Different export strategies are used for different commodities trading, reflecting the competition aspect and margins that characterize each commodity. Wheat trading is still mainly governed by the traditional and safe but more costly letter of credit instrument, whereas rice is increasingly traded with CAD instruments which provide more flexibility but at the same time induce more risks to traders. This chapter describes the major international trade finance practices with regards to the imports of bulk foods by LDCs and NFIDCs.
When a seller has a long-standing commercial relation with a buyer, he may be willing to sell on open account terms. Under this payment arrangement, the seller usually gives a revolving credit line to the buyer. The buyer has a reasonable time to process the commodities and sell them before he has to reimburse; in effect, the seller finances the buyer’s working capital needs.
Certain large traders are by-passing the traditional, more secure methods of financing such as letters of credit and are now making sales on an open account basis, to reduce transaction costs. This is relatively rare in the case of developing country food imports, but if it occurs, the situation is often one of the seller being a nationally-based exporter (rather than an international trade house), and the buyer a processor (for instance, a flour mill).
This mechanism is widely used in rice trading. With privatization taking place in most importing countries, new players are stepping in and international traders are faced with stiff competition which leads them to providing financing facilities to their importers. Today the rice market is a private, well-organized sector with new operators (these a re basically previous wholesalers who are typically becoming operators in their countries as is the case in Senegal) confirming their position.. International trades are taking the risk of delivery until the arrival of goods to the port of destination. They would normally require a down payment of 10 percent as a guarantee of payment. They would provide the financing provided that there is margin for it.
Once the draft is avalized by a local bank, the international trader is able to discount the notes and will receive payment even before shipping the goods. Discounting avalized notes is a financing mechanism that is widely used in Africa in rice trading. It is mainly the bank that takes the risk. Discounting may be done by either international or local banks. The first rule that banks will apply to mitigate the risk is to keep control over the goods. This is done basically by having all shipping documents assigned to them. Once the goods arrive at their destination, they become stock and their control is carried out through collateral management. Another strategy to reduce risk is insurance of the goods while they are shipped and in stock. In addition to this, the bank will also take a margin (15-25 percent) on the line of credit that is open to the buyers.
Letter of credits are used for exports by state entities to large buyers who are often also state entities (government-to-government). These exports are often credit-driven: credit is used as a competitive tool. Repayment periods often go beyond the commercial length of the transaction. The financing mechanism is generally either a direct credit or a confirmed deferred payment letter of credit.
Letters of credit in wheat trading still play a significant role. They are usually issued in the buyer's country and confirmed by a well-established international bank. Deferred letters of credit are opened at the moment the transaction is put in place in order to avoid market and transport risks. Once the letters of credit are confirmed, they can be discounted by the confirming bank and the deferred sales agreement is transferred into sight sales.
The role of letters of credit in rice trading is decreasing in favour of CAD. This is mainly due to competition in this arena. Nowadays letters of credit represent less than half of the transactions. They are mainly used when dealing with new or difficult markets.
Private-sector imports in countries where such trade is longer established, from the US or other countries with large credit insurance programmes, may be under letters of credit. In these cases, the importer often opens a L/C, in US dollars or another hard currency. This is a costly matter for him as the local bank often requires large collateral, but this cost is compensated by the fact that the seller can benefit from affordable credit insurance (much lower than the normal sovereign risk premium) and can therefore pass on the benefits of this in the grain price. The bank may provide deferred payment terms under the L/C, but the seller (particularly if it is a trading company) will generally not provide any credit terms.
Trade under letters of credit is feasible where banks in the exporter’s country have good credit lines with banks in the importer’s country, and the importer is able to provide the required securities to his bank. In many cases, bank-to-bank credit lines are a bottleneck. Most western banks, even the largest, have for example credit lines with banks in not more than a dozen or so African countries. For regional trade, such credit lines can be even more difficult to find. There are exceptions, however. For example, country credit lines are not a bottleneck for India-Bangladesh relations. The major supplier of wheat and rice to Bangladesh is now India, and thus, a major part of these imports take place under L/Cs opened by a Bangladeshi bank, and confirmed by an Indian bank.
The ability of an importer to open a L/C can also be a restrictive factor because of government intervention. Regulations in Egypt, similar to those in several other LDCs and NFIDCs, have the effect of forcing importers to carry the full financing burden of food imports in hard currency. In March 1999, the Central Bank of Egypt advised all banks operating in Egypt that L/Cs must be covered 100 percent in cash by the importer. This replaced the previous procedure whereby banks and their clients reached their own agreements and covered, usually, only 10-20 percent of the L/C’s value. As a result of this new role, a shortage of US dollars in the market was recognized by foreign companies operating in Egypt. In general, the exporter may not ship the goods before the opening of a letter of credit has been notified by the Egyptian bank. If he does so, the importer can be fined up to a maximum of the value of the goods.
Even where such full collateralization is not imposed by the Government, it is often practised: banks do not have the expertise to use other, more efficient ways to secure their loans.
Counter purchase and barter are occasionally used for food imports by NFIDCs and LDCs. Examples are small-scale transactions between Nepal and China, several schemes used by Cuba for its imports, and a barter agreement signed in December 2002 between the Egyptian state company, the Food Industries Holding Company, and the Syrian Arab Republic to export 100 000 tonnes of Syrian durum wheat in exchange for Egyptian rice and potatoes.
However, the more important forms of counter trade for these countries are the so-called Bilateral Purchase Agreements, a governmental framework for counter purchases. BPAs have been used as the financing framework for exports of several food products to NFIDCs and LDCs.
Palm oil
Malaysia has entered into BPAs with the governments of Bangladesh, Cuba, Djibouti, Egypt, Myanmar and Sudan allowing them to import palm oil from Malaysia against payment in each country’s commodities. Under these so-called Palm Oil Credit and Payment Arrangement (POCPA), the importer can defer payments for two years (at a LIBOR-related interest rate for US dollar-denominated loans, and in other standard reference rates for loans denominated in other currencies, such as the Yen). This has been a useful export promotion tool. In 2000, US$135 million of palm oil was exported under the POCPA scheme. Only countries which agree to import a certain minimum volume of palm oil from Malaysia can participate in the scheme.
Wheat
In early 2003, Egypt entered into a five-year agreement with the Russian Federation and Ukraine enabling it to pay for Russian and Ukrainian wheat with Egyptian products - presumably under a BPA arrangement. Pakistan has discussed a possible BPA with Afghanistan, for the export of wheat to that country, but finally decided to provide credit insurance to private exporters instead.
Rice
As governments of exporting countries intensified their efforts to secure rice sales, a large number of transactions have been made in recent years under government-to-government agreements, often in the form of barter trade arrangements. This includes arrangements between exporters such as Myanmar, Pakistan, Thailand and Viet Nam, and importers such as the Malaysia, Indonesia, the Islamic Republic of Iran, Iraq, the Philippines and Sri Lanka. Thailand and Viet Nam have also BPAs with Cuba which cover, inter alia, Cuba’s imports of rice from these countries.
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Box 7 Eastern and southern Africa contain a number of countries that are systematically surplus producers of the region’s main food crop, white maize (in particular, South Africa, the United Republic of Tanzania and Uganda), or were a surplus producer before government policies changed (Zimbabwe). At the same time, several countries in the region are maize importers, on a regular basis or in some years. There are also similar surpluses and deficits in the region for other foods. Thus, there should in principle be a good market for regional trade. Problems with financing such trade, however, frequently intervene. The experiences with credit sales within the region have not been uniformly positive. For instance, several sellers of maize to Zambia, including the government Grain Marketing Board, are still waiting to be paid for past deliveries. Both in the case of private and public buyers, payment can be uncertain. At the same time, buyers in the region often need credit, and preferably an international loan because local interest rates are so high (even for US dollar-denominated loans). There are some cases where importers can borrow outright from an international bank, particularly if they can provide a government guarantee. But in most cases, the supplier will have to arrange some form of finance. Western suppliers have a definite advantage in this respect: their national export credit or credit insurance agencies can cover their risks of credit sales. Within African countries, the structures to cover such risks hardly exist. Moreover, pre-shipment credit facilities, necessary to collect sufficient grains to fulfil an export contract, do not exist in most countries. A local grain trader may convince the national central bank to give a guarantee to the local banks against the risk that another government in the region defaults on its obligations, but this is usually an ad-hoc arrangement, based more on relationships than on rules. Prospective exporters of food crops in the region have, therefore, to be creative in order to sell on the credit terms demanded by prospective buyers in the region, particularly as non-African suppliers can often meet such credit demands. The solution many have opted for is warehouse receipt finance. For example, if an exporter of the United Republic of Tanzania wants to sell maize to a private Zambian flour mill, he finds a South African bank which is, in principle, willing to finance the transaction. In order to deal with the financing risks, the bank will wish to control the actual transaction, so will place its own agents in the exporter’s warehouse to monitor the arrival of the maize and prevent it leaving without the bank’s permission. These collateral management agents will then check the companies responsible for moving the goods to Zambia, and ensure that the transport arrangements are satisfactory. On arrival in Zambia, the maize is placed in the flour mill’s warehouse, but again under the control of the collateral manager. The flour mill owner is only allowed to take out maize with the permission of the bank, and only enough to enable the mill to work optimally is released at any one time. The remainder of the maize, as well as the finished, unsold flour, is kept in the warehouse under the control of the collateral manager. If flour is sold under a credit arrangement, the buyer has to make an unconditional agreement to pay on an escrow account controlled by the bank. These arrangements, backed by an array of insurance policies, are what make many regional grain trade transactions possible. There is certainly potential for expansion, though: too many banks in the region are unaware of these financing mechanisms, and are unable to provide their (potential) exporters the credit mechanisms that they need in order to sell on the regional market. In some countries, banks make an outright purchase of the goods in a warehouse, with a repurchase agreement with the original owner that he will buy it back after a certain time at a certain mark-up; this gives additional legal protection to the bank. This mechanism, however, is hardly (if at all) used in LDCs and NFIDCs, except in Islamic finance transactions (and in these, the bank’s control over the inventory is often incomplete). |
For private-sector imports in recently privatized grain trading systems, the mechanism used is often warehouse receipt finance. A major reason for this is that the new importers have not yet had time to build up a track record with either local or international banks, or with international suppliers.
In several sub-Saharan African NFIDCs and LDCs (to name but a few, Côte d’Ivoire, Mali, Mauritania and Zambia), warehouse receipt finance is much used in food imports, particularly for wheat, maize and rice, and also sugar. The mechanism is used to enable food processors (e.g. flour mills) to import the raw material and process it, and also, in the import of the final product. Generally, it is used by international traders who have an office in the country, and who extend their international finance to the local food flows by keeping control over the physical inventory. Warehouse receipt finance is common in rice trading where a tri-partite agreement is signed between the trader, the bank and the collateral manager, which will secure the repayment of the transaction.
Intra-firm trade concerns imports by large traders into a country where they have a local office. Normally, sales to the local company will be in US dollars on a CIF basis, on deferred terms. Often these types of sales are used to provide funding to the local office by the head office. Trade finance is the cheapest source of international finance, and this method is therefore more convenient than obtaining working capital financing via a local bank in either US dollars or local currency. Sometimes the head office discounts such a receivable with an international bank, but in most cases it will be financed by the head office via its regular funding vehicles. Islamic funding is a favourite funding vehicle for these types of trades. The local office will sell to local buyers, either on a cash basis, or under small, rapidly revolving credit lines.
Commonly, imports by large corporate (often processors) or government-owned entities are on a cash on delivery basis, using either CAD or, less often, letters of credit (these are more expensive, and these buyers often have enough of a track record to avoid using them). These buyers normally raise the funds from the local banking system (through hard currency loans, meaning that they take the currency risk), sometimes using expensive overdraft facilities; at times, local stocks are pledged as collateral. In certain cases, they may be able to raise funds from international banks thanks to a government guarantee.
