Experienced international executives indicate that a company seeking international expansion through investment must be intimately familiar with the market it chooses to penetrate, and the risks it may incur. For example, investors will need to understand the obstacles and risks involved in staffing, integrating distribution, financing operations, currency fluctuations, changing foreign investment legislation, and economic and social unrest. Likewise, exporters and their lenders must be cognizant of the inherent risks of exporting. These may be broken down into pre- and post-export risks. Pre-export risks, which are similar to domestic pre-shipment risks, primarily involve the performance capability of the seller. Post-export risk involves commercial and political risks.

Pre- and Post-Export Risk

Stated above, pre-export risks primarily involve the performance capability of the seller. Thus, prior to providing a manufacturer with export working capital, lenders must consider a variety of factors in order to determine this level of risk. Similar to domestic risk analysis, the lender must assess the strength of the manufacturer’s balance sheet. But the greater challenge is to accurately assess the manufacturer’s ability to produce the product, meet all required L/C specifications, and ship according to an agreed upon time frame. In doing so, it is essential that each lender pay particular attention to the credibility of the company’s management.

This assessment is critical, since the liquidation of working capital debt is contingent upon the manufacturer successfully completing this cash conversion cycle. And to minimize any misunderstanding, it is important to structure the loan as “self liquidating.” This requires the exporter/manufacturer to repay the loan by the orderly liquidation of accounts receivable arising from the transaction.

To successfully complete an overseas transaction, the exporter also must be cognizant of several other pre-export risks of which the lender often will not be aware. These include the exporter’s ability to satisfy all importing country regulations and accurately account for duties and taxes. Should a problem occur that prevents the exporter from completing these tasks, the deal could sour. For lenders to provide the financial products and services that best satisfy the exporter’s needs, lenders must be able to put their feet in the exporter’s shoes, understand his/her interests and analyze the obstacles and risks which must be faced. But no lender can properly carry out these responsibilities unless he/she understands international trade, and the multitude of risks and barriers it presents.

Stated above, post-export risk primarily involves commercial and political risks. Commercial risks are often viewed in terms of transaction strength focusing on the receivables. This involves the buyer’s ability to pay for the goods, the terms of payment, and the credibility of the buyer’s bank. Political risks are often assessed in terms of country stability. Keep in mind that commercial and political risks often become blurred and intermixed, as one impacts the other.

Buyer Risk

A very important rule of prudent exporters and lenders is to “know the customer.” Whether an export sale is generated through a domestic trade show or from an export marketing campaign, it’s necessary to understand the buyer’s abilities. It also is important that the exporter commits the resources necessary to develop a strong and long-term relationship, which eventually may lead to extending credit payment terms. However, the longer the length of the credit terms, the greater the degree of risk, since it is difficult to determine if the foreign customer will have the financial capacity to make a payment six or 12 months later.

In order to determine whether or not debt obligations are likely to be paid on time, a number of questions must be asked and answered. For example, is the foreign customer creditworthy for the shipment, or suffering cash flow problems that might delay payment? What is the foreign customer’s reputation for honesty and dependability? How long has the prospect been with his/her bank? Would he/she object if the exporter’s bank writes to this bank to ask for an opinion on the company?

When an importer is prepared to disclose the name and address of his/her banker with the expectation that the banker will be questioned about his/her reputation, a certain degree of confidence exists. This can be very encouraging to the seller. Consequently, a bank report serves as an important tool to facilitate an overseas sale from the perspective of the financiers. Banks worldwide expect to be asked to support their customers with a credit reference, and are only too happy to provide this service on behalf of their better customers. For additional information, one should consult credit reporting agencies, such as Dun & Bradstreet, who specialize in collecting valuable company data on firms worldwide.

Foreign Bank Risk

Foreign bank risk involves the ability of the importer’s bank to satisfy its payment responsibilities. To identify risks possibly leading to non-payment, it is important to scrutinize the foreign bank’s reputation. This is subject to various factors, including history, ownership, capital, competence, and domicile.

When reviewing a bank’s history, one should consider its level of experience. In a global environment where new banks are formed and disappear daily, a track record is one of its more valuable intangible assets. The bank’s ownership is also an important factor in determining risk. Thus, if a small bank in a developing economy has an unfamiliar name, but is partly owned by a larger, well-known institution, it may be entrusted to represent the interests and attitudes of the owner. If the capital of a bank is not adequate to support its obligations, it can be judged to be leveraged in the same manner as any borrowing corporation. Prudent bankers assessing bank risk, therefore, should be careful to assess the capital adequacy of a bank supporting a transaction.

The level of competence of the bank guaranteeing payment is also an important factor. Are the bank’s documentary credits obscure and difficult to understand? Is the transaction presented in a clear and simple format which is consistent with standards (i.e., the Uniform Customer and Practice for Documentary Credits, as published by the International Chamber of Commerce)? These questions should be answered before proceeding. And, finally, the domicile of a bank must be considered. Prudent exporters will need to review the stability of the country in which the bank is located (see country risk below). To eliminate this risk, exporters often will seek letters of credit confirmed by a U.S. bank. But if a letter of credit is confirmed by the U.S. branch of the issuing bank located abroad, what are the risks? To be comfortable on this subject, question what the actions of the branch will be if the bank’s head office closes.

Country Risk

In addition to buyer and bank risk, exporters and lenders must keep abreast of foreign country risk. Very simply, one must consider the political and commercial conditions of the importer’s country since it can adversely affect the foreign customer or his/her bank’s ability and willingness to pay debt obligations. In many developing countries, a change in leadership is often a time of instability. Should social turmoil envelop a nation, the disruption of activities could put the importer out of business. Should a military coup take place, a succeeding government may reverse economic policy that could prevent the exporter from getting paid.

Consequently, it is important to be aware of the political relationship between the United States and target countries. A stronger relationship often provides more confidence in the foreign country government. Keep in mind that bankers, political analysts and economists often do a more in-depth analysis than do corporate credit managers.

Political factors also have a major impact on each country’s currency. Stated earlier, the exporter’s ability to manage currency risk and offer liberal credit terms to foreign importers can give him/her a much needed edge over the competition. Accepting a foreign currency for payment is one way to achieve this. However, in addition to the risks of getting paid late, or not at all, adverse currency fluctuation resulting from political or economic instability can eat into the exporter’s profits or cause a loss. For example, if a U.S.-based manufacturer ships $50,000 worth of goods to a foreign importer with payment due in the foreign currency in 90 days, and at the end of 90 days the foreign currency loses 30 percent of its value, the U.S. exporter would lose 30 percent on the transaction.

When a country’s currency depreciates by half its value, it takes twice as much of that currency to import the same value of goods as it did before. As a result, the country will usually import less than it did before. Factors affecting currency trends are complex and contingent on seemingly independent activities, rhetoric and highly fluid capital shifts, in addition to macroeconomic forces. As such, predicting whether a currency will increase or decrease in value is very difficult and extremely risky. In fact, many economists, traders and investors did not foresee the chain reaction or identify the complex factors that led to Asian currency devaluations which began in 1997 (discussed later).

In today’s global economy, it is essential to plan future receivables, payables and capital flows — making it necessary to manage foreign currency exposure. This task requires an understanding and assessment of a variety of factors and conditions affecting currency volatility, including the following three important indicators:

  1. Macroeconomic fundamentals (economic growth, inflation, unemployment, and balances of trade);
  2. Political considerations (upcoming elections, policies, and the level of confidence in the government); and
  3. Social considerations (labor unrest and violence).

In theory, if the importing country’s economy has been stagnating and unemployment is high, there’s a chance the government will lower interest rates and/or increase spending. Should this occur, the value of the importing country’s currency likely will drop. On the other hand, if the economy is booming ahead, there’s a good chance the currency will become stronger. However, in today’s actively traded markets, the considerations and potential responses are infinite. As a result, managing foreign currency exposure may require more than research-based predictions — it may demand a sound hedging strategy. Through the use of spot, forward and option contracts, the exporter can insulate his/her business and minimize the risks against losses due to currency fluctuations.

How do these contracts work? Spot contracts convert the buyer’s currency at current rates for settlement within two business days. This simple method allows the exporter to take immediate advantage of favorable rates, but provides no hedge against future rate changes. Forward contracts enable the exporter to lock in a rate of exchange for three days to 12 months. This popular hedging method provides protection against loss well into the future. Option contracts offer the exporter the ability to lock in a rate over a period of approximately one month.

In some countries, currency exchange controls affect the value of the currency, preventing an accurate market-driven exchange rate. As such, transactions may not reflect their true value. For example, some former communist countries had maintained distorted currency exchange rates to the extent of preventing Western trade, except for barter trade.

Mitigating Risks and Profiting

To help lenders mitigate risks, the SBA has developed a unique, high-tech, internet-based automated system called the SBA Export Express. It electronically provides all decision-making tools needed to evaluate export transactions, provides importer and foreign bank risk-analysis, and gives an immediate indication of the SBA’s willingness to guarantee export working capital loans. As a result, it makes the SBA’s Export Working Capital Program (see Appendix A) easier for lenders, so accessing to financing is easier for exporters. The steps are simple.

  • The exporter provides the lender with the importer’s name, address, bank and payment terms.
  • The lender logs onto the SBA Export Express website and simply types in the data.
  • In lightning speed, Dun & Bradstreet and Thompson Bank Watch files are accessed to provide crucial credit information on the foreign customer and bank. The data is then directed through an SBA scoring system to determine the level of country and commercial risk. In seconds, the system provides an indication of the SBA’s willingness to guarantee the loan.
  • If a positive indication is received, the lender then submits a completed SBA loan application to the nearest U.S. Export Assistance Center for processing.
  • If the indication is negative, the lender receives an immediate on-line explanation and suggestions on how to restructure the transaction with less risk.
  • Within 10 days or less, the SBA confirms or denies the guarantee.

The SBA’s Export Working Capital Guarantee Program (EWCP), electronically made available through the SBA Export Express, offers lenders protection against pre-export risks by mitigating losses caused by non-performance of the borrower. If the borrower fails to perform and the receivable is not created, the lender can obtain repayment from the SBA 90 percent guarantee (see Appendix A).

Stated earlier, use of a letter of credit alleviates most post-export risks by shifting the repayment responsibility from the buyer to the buyer’s bank. To further mitigate this risk, the use of a “confirmed” letter of credit by a U.S. bank shifts payment responsibilities to the U.S. bank. Thus, if the foreign bank refuses to meet its obligations to pay a properly presented letter of credit and if the exceptions cannot be resolved, the SBA’s EWCP will protect the lender against losses. Very importantly, the EWCP protects the lender’s equity position against loss, and provides credit to the borrower when the lender is not comfortable with the risk.

The bottom line: the SBA’s EWCP offers lenders improved profitability by helping them provide greater assistance to exporters, with little risk. Thus, lenders will be in a better position to provide more short-term export working capital loans to small business exporters.

Typical Schedule of Charges for Commercial Banks

Export Letters of Credit

  • Advising Fee: $55 and up
  • Confirmation: Minimum of $150 but varies by country (usually a percentage of L/C)
  • Amendment: $45 and up for each amendment
  • Discrepancy: $60 and up for each discrepancy
  • Negotiation/Payment: 1/8%, minimum $90
  • Transfer of L/C: 1/4%, minimum $200
  • Assignment of Proceeds: 1/8%, minimum $125

Acceptance/Deferred Payment

  • Discount: By arrangement, typically starts at 1.5% of L/C amount. Then added is current market rate of Bankers Acceptance, which varies by country.
  • Unused or Canceled: $50 and up
  • Reimbursement from 3rd Bank: $40 and up
  • Payment of Proceeds to a 3rd Bank: $25 and up
  • Electronic Messages: $25 and up
  • Mail (domestic/intl.): $4/$11 and up
  • Courier (domestic/intl.): $20/$60 and up
  • Fax (per page, maximum $17): $5 per page

Documentary Collections

  • Export Direct Collections: $65 and up
  • Export Standard: $75 and up
  • Tracer: $15 and up
  • Payment of Proceeds to a 3rd Bank: $25 and up
  • Electronic Payment Notification: $15 and up
  • Bank to Bank Payment: $60 and up
  • Money Transfer: $25 and up

Revolving Line of Credit

  • Bank Front End Fee: 1% of Line Amount due at loan signing
  • Unused Balance Fee: 1/8% per month on unused balance
  • Loan Rate: Prime + 2 % and up TMWP
  • Legal Fees: $500 and up due at loan signing
  • Documentation Fees: $500 and up due at loan signing
  • Audit: $250 per hour done by bank, twice a year if statements not audited.
  • Lock Box Fees: Typical business checking charges
  • Life Insurance: Policy Prices at market rate
  • Export Credit Insurance: Policy Prices at market rate

Government Guarantee Fees:

  • SBA Fee: 1/4% of line amount due at loan signing

The Case of Russia

Many bankers, investors and traders today agree that Russia deserves careful political risk consideration. The Russian Federation, previously the dominant member of the former Soviet Union, is in a period of major economic, political and social transition. With this upheaval has come much change — and vast opportunities. The country’s demand for U.S. goods and investment has grown at a considerable rate. The ongoing transitional period, however, has made doing business in Russia difficult. Unlike other countries in Central and Eastern Europe that appear to be adapting more easily to a market economy, Russia has no institutional memory of democracy or free markets and is struggling to make the transition. Its commercial environment, therefore, is characterized by high risk and uncertainty for the foreseeable future.

Trade relations between the United States and Russia are governed primarily by an agreement negotiated originally with the former Soviet Union, then altered and ratified by the Russian parliament. Under the auspices of this treaty, Russia was extended Most Favored Nation (MFN) trade status in 1992, the normal trading status granted to 220 of the United States’ 228 trading partners. When a foreign country has this status (now called Normal Trade Relations or NTR), its goods enter the United States at a normal duty rate. If not, its goods are assessed duty rates exceeding 50 percent, making them noncompetitive here. Countries currently not receiving NTR status include Afghanistan, Cambodia, Cuba, Laos, Libya, North Korea, Vietnam, and Yugoslavia.

In 1993, based on overall potential demand, the U.S. Department of Commerce identified Russia as one of the Big Emerging Markets. Although the Russian economy has incurred serious setbacks, U.S. total exports there increased from $2.1 billion in 1992 to $3.6 billion in 1998. In June 1997, Russia was made a member of the G-7 (now referred to as the G-8) group of countries, and is currently negotiating political and economic ties that undoubtedly will shape its future.

Despite this political and economic uncertainty, most U.S. companies operating in Russia believe the opportunities more than justify the risks. Nevertheless, Russia’s political risk continues to be a primary concern and should be given a great deal of attention, requiring constant monitoring.

The Case of East Asian Currency Devaluations

Over recent years, currency values have been extremely volatile in East Asia. With the front page news of plunging currencies — beginning with the Thai baht and quickly affecting the Malaysian ringgit, the Indonesian rupiah, and the Korean won — it is easy to understand the damage caused by currency fluctuations. Not only did the domino effect put pressure on traditionally strong currencies, but it also resulted in losses on stock exchanges around the world — including the New York Stock Exchange.

A number of factors led to the Asian economic crisis that began in early 1997. During the 1990s, Southeast Asian countries increasingly pegged their currencies to the U.S. dollar. After mid-1995, the dollar began to appreciate vis-à-vis the Japanese yen and major European currencies. Shortly thereafter, China devalued its currency. Southeast Asian exports became more expensive and less competitive, and pressure mounted on exchange rates. As foreign investment flowed into East Asia, a rising share was directed into speculative real estate ventures, which promoted a building boom that fueled domestic demand and stimulated imports. Asian bankers borrowed a great deal of money from abroad, much of it in U.S. dollars at lower interest rates than could have been obtained domestically, and they did not always lend it wisely. Loans were made to domestic developers in local currencies that, in turn, became exposed to exchange risks. Compounding weakening financial systems and unsustainable exchange-rate regimes were fragile legal and regulatory systems.

As China opened its doors to foreign investment, capital was diverted there from East Asian countries. Unprepared for this, Thailand, which had few investment controls in place, and failed to address its current account deficit, invest in a higher technology manufacturing/infrastructure, or sufficiently educate its labor force, found it could not compete with China in labor intensive sectors. In late 1996, increasing numbers of foreign investors began to question Thailand’s ability to repay its loans, and proceeded to move their money out of the country. Fearing this would result in a loss of value in the Thai baht, in February 1997, foreign investors and Thai companies began to convert the baht into U.S. dollars — accelerating a loss of confidence in the currency.

In response, the Thai central bank began buying up the baht with its dollar reserves, and raised interest rates in hopes that this new demand would increase the currency’s value and make baht-based savings and bonds more attractive investments. The rise in interest rates, however, made borrowing more expensive and drove down demand and prices for stock and real estate. With diminished reserves, the central bank was forced to float the baht, resulting in its downward spiral. And, since it took many more bahts to pay off dollar-denominated loans, defaults became common. Investors and businesses in neighboring Philippines, Malaysia and Indonesia concluded that these economies shared some of the same weaknesses as Thailand. Fearing the local currencies also would tumble, they began converting them into dollars, resulting in a self-fulfilling prophecy. Malaysia, compared to Thailand, was better able to compete with China in low technology sectors. However, its economy was not able to support the country’s mega-projects and poor real estate ventures that had diverted huge resources.

The impact of the Asian financial crisis was felt in many ways. During the crisis, Federal Reserve Chairman, Alan Greenspan, stated that with the crisis curtailing the financing available in foreign currencies, many Asian economies would have no choice but to cut back their imports sharply. He was right. Prior to the crisis, more U.S. merchandise trade crossed the Pacific Ocean than the Atlantic. In 1997, U.S. exports to Pacific Rim countries reached almost $194 billion. In 1998, they dropped to $167 billion.

How did this impact the United States? In 1996, 29 percent of U.S. merchandise exports were shipped to the “Asian 10,” which is comprised of China, Hong Kong, Indonesia, Japan, Malaysia, Philippines, Singapore, South Korea, Taiwan, and Thailand. Of these countries, the economic crisis more severely affected Indonesia, Thailand, Malaysia, Philippines, and South Korea, whose currencies experienced significant devaluations.

Certain U.S. regions that were more dependent on exports to East Asia were affected to a greater extent than less dependent regions. Thus, eight U.S. states exported at least 50 percent of their goods to the “Asian 10” in 1996. New Mexico exported 68.8 percent of its goods there; followed by Hawaii with 64.6 percent; Oregon, 63.9 percent; Alaska, 57.9 percent; Nebraska, 55.7 percent; Washington, 54.6 percent; California, 51.9 percent; and Idaho, 50 percent. In terms of value, California was the biggest global exporter by far among all U.S. states, and the “Asian 10” were among California’s top 22 export destinations. As a result, the weakening Asian demand for imports impacted California to a greater extent than many other states. Five states — Florida, Michigan, Montana, North Dakota, and Vermont — shipped 10 percent or less of their exports to the “Asian 10” and thus, were less affected.

In turn, U.S. imports from Asia rose significantly, resulting in a larger U.S. trade deficit. More specifically, imports from Asia of low technology-produced goods, where materials and other inputs were sourced domestically, were anticipated to increase in large amounts. Textile and fabrics for apparel were a clear example of this. Jim Schelley, vice president and general manager of the New York City-based CIT Group/Commercial Services, claimed that Japan, China, Malaysia and the Philippines posed the most immediate threat to U.S. manufacturers due to their more competitive export prices resulting from the Asian currency devaluations. In terms of the textile industry, Schelley contended these countries were able to use domestic raw materials for the manufacturing of textiles and would not hesitate to compete on price with goods produced in the U.S.

On the other hand, imports from East Asian manufacturers who typically sourced their components outside their countries, and required foreign currencies to buy them, were not expected to rise as fast. Thus, when a country’s currency depreciates, it takes more of that currency to buy other currencies.

Analysts predicted that East Asian manufacturers, impoverished by currency devaluations and a precipitous drop in domestic demand, would work off inventories and export themselves back to health. Japan, with economic and financial problems of its own, did not provide the economic engine required to absorb additional imports. As in the past, the U.S. market became the primary target, with Europe following, putting downward pressure on domestic and foreign prices.

In terms of sourcing product, U.S. importers needed to ensure that foreign suppliers were able to continue purchasing their inputs and ship their goods. Schelley cautioned that companies doing business in Asia would need to reevaluate their risks and question past assumptions. “In situations like this,” he said, “the greatest risk can usually be found in the supply chain.”

In an attempt to lure fresh investment, East Asian companies increasingly pursued foreign partners with the ability to provide capital and technology. In return, they made attractive offers that would provide lucrative opportunities. Overall, severe adversity in East Asia forced adaptations that would not have been politically feasible during favorable economic times. Thus, the crisis became an impetus to liberalize investment laws and opened sectors once reserved only for domestic companies.

The Case of the Single European Currency

The advent of the euro, the new single European currency, can make exporting and importing easier — or more difficult, depending on a company’s perspective. Nevertheless, in the short-term, companies need to know how the euro will affect their business so they can take the necessary steps to gain new opportunities and mitigate risks.

On January 1, 1999, the euro became the official currency of 11 of the 15 European Union (EU) member states. This group of countries, referred to as Euroland, includes: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain. From January 1, 1999, through December 31, 2001, Euroland businesses are free to use either the euro or their national currency for non-cash transactions. On January 1, 2002, euro notes and coins will be made available. After that, national currencies gradually will be withdrawn and will cease to exist on July 1, 2002.

Euroland represents an economy almost as large as the United States’. Should all 15 EU countries become members, which is very likely, Euroland will become the largest world market. And as Euroland becomes stronger and more influential, the value of the euro should increase. On May 14, 1999, one U.S. dollar was worth 0.9397 euros. However, analysts believe a large shift from dollars to euros — a somewhat likely scenario — may cause significant fluctuations in this exchange rate. In turn, this quickly could be followed by a precipitous fall in the value of the dollar. Overall, a stronger euro would make Euroland exports more expensive and decrease the region’s level of competitiveness. On the other hand, U.S. goods and services would be more attractive in Euroland, benefiting U.S. exporters. If a large shift from euros to dollars occurs, the opposite situation would happen.

In order to do business successfully with Euroland companies, many U.S. firms still need to get up to speed. This means adapting price lists, ledgers, receivables, and other financial systems to the euro. To achieve this, companies will need to invest in new software and training, so they can accurately process monetary data in euros. If not, firms will risk losing business. In addition, companies need to understand the euro’s impact on letters of credit.

The International Chamber of Commerce (ICC), the recognized world business organization based in Paris, has published euro guidelines relating to international commercial practices, including transactions under the UCP 500. According to the ICC’s report on the euro’s impact, the European single currency “shall not have the effect of altering, discharging or excusing performance under any instrument subject to ICC Rules.” The ICC recommends that exporters add language to their L/Cs to ensure they are subject to the Uniform Customs and Practices for Documentary Credits that concerns euros.

According to a European Commission, transaction costs related to the existence of different currencies in the EU amounted to approximately 0.5 percent of EU gross domestic product (GDP). Other studies have estimated this cost closer to 1 percent. These savings, combined with greater macroeconomic stability and reduced governmental deficits, are anticipated to result in economically stronger euro participant economies. In turn, this is expected to result in greater imports from the United States. According to an International Monetary Fund study, the impact of the euro on participating member economies will be an increase GDP growth of .2 percent in the year 2000, .9 percent in 2001, 1 percent in 2002, 1.1 percent in 2003, and 2.9 percent in 2010. The economies of non-European G-7 and developing countries are predicted to grow by .1 percent and .2 percent, respectively, in 2003.

In the short-term, the cost of effectively dealing with the euro may be significant. However, over the long-term, the cost of doing business in Euroland will decrease. No longer will U.S. firms need to incur the costs of converting the dollar into a dozen different currencies. Furthermore, European prices should decrease, since it is now easier to compare the prices of goods and services in any of the Euroland countries. This means Euroland firms will be forced to become more competitive.

As a result of the ever changing global environment, it is important to understand as much as possible about a foreign country’s exchange rate mechanism and how it may operate. It is also essential that the lender work closely with the exporter to determine whether it is wise to accept a particular foreign currency as payment, the type of hedging mechanism that may satisfy the exporter’s needs, and the terms that will allow the exporter to remain competitive while limiting risks.

This appeared as Chapter Three in the book Trade and Finance For Lenders, 1999.

John Manzella
About The Author John Manzella [Full Bio]
John Manzella, founder of the ManzellaReport.com, is a world-recognized speaker, author and an international columnist on global business, trade policy, labor, and economic trends. His latest book is Global America: Understanding Global and Economic Trends and How To Ensure Competitiveness.

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