Questions: Question-1: Identify key international trade and finance principles in the case. Question-2: What are the financial instruments used to facilitate foreign trade? Question-3: What are the typical foreign trade transactions involved in the case?

Financing the foreign trade: the case of an India textile exporter Namita Rajput, Rohit Bhagat and Saachi Bhutani Bhagat Namita Rajput is Associate Professor at University of Delhi, New Delhi, India. Rohit Bhagat is Manager at Yes Bank Ltd, New Delhi, India. Saachi Bhutani Bhagat is Assistant Professor at University of Delhi, New Delhi, India. Introduction Mr Nitin Gupta, MD and CEO of Latest Fashions Pvt. Ltd., was sitting in his office on a mid-June morning thinking about the achievements his company had made since its inception. Nitin had just come back from the Annual General Meeting of Latest Fashions Pvt. Ltd. where he learned that the company had achieved a 30 per cent increase in sales compared to the previous financial year. Both the shareholders and employees were happy with the companys performance, how the organisation had grown over the years and the companys current goal of a 40 per cent increase in sales for the present year. But Nitin was worried about the working capital funds required to support the projected sales and was expecting large export orders from Europe and America that had to be supplied before Christmas. To deliver the orders on time, Nitin needed to procure raw material, hire labour and arrange for warehousing and shipping. Where will these funds come from? Nitin asked Mr Narayan Verma, his trusted financial advisor and the companys Chartered Accountant. Textile industry in India The textile industry in India dates back to the Harappan Civilization. India is the second largest producer of textiles and garments in the world; in addition, the sector contributes about 11 per cent of the countrys export revenues [http://texmin.nic.in/annualrep/ar_12_ 13_english.pdf (accessed 3 August 2014)] and is the second largest provider of employment after agriculture in the country [www.ibef.org/industry/textiles.aspx (accessed 3 August 2014)]. The Working Group Report constituted by the Planning Commission that aimed to boost Indias manufacturing exports during the 12th Five Year Plan (2012-2017), estimates Indias exports of Textiles and Clothing to be US$64.11 billion by the end of March 2017. Indian textile products are exported to more than a hundred countries, and the USA and European Union are responsible for approximately two-thirds of Indias exports. Other countries that account for Indias exports include: Canada, UAE, Japan, Saudi Arabia, The Republic of Korea, Bangladesh and Turkey (Figure 1). Background Latest Fashions Pvt. Ltd. was set up 10 years previously by Nitin, an MBA graduate, with a modest promoter funding of INR1 million. Engaged in the business of exporting ready-made apparel and kidswear, exports contributed to the major part of the sales of the company. Over the years, as the company expanded and the requirement for funds to support the working capital needs of the company increased, Nitin managed to infuse his own money and profits into the company and now the company has reached a turnover of INR500 million. Disclaimer. This case is written solely for educational purposes and is not intended to represent successful or unsuccessful managerial decision making. The author/s may have disguised names; financial and other recognizable information to protect confidentiality. DOI 10.1108/EEMCS-08-2014-0201 VOL. 5 NO. 4 2015, pp. 1-11, Emerald Group Publishing Limited, ISSN 2045-0621 EMERALD EMERGING MARKETS CASE STUDIES PAGE 1 Downloaded by Swinburne University of Technology At 06:42 27 March 2017 (PT) Mr Narayan Verma has long been a close confidante of Nitin and had often guided Nitin on financial matters since the business began. Knowing Nitins concerns, Narayan appraised him about the different sources of financing in international trade. Nitin and Narayan decided to meet banks and various agencies in the business of financing of foreign trade to discuss the merits and demerits of each source of finance and eventually decided on how to finance their growing working capital need. Meeting with the bank Narayan arranged a meeting with the Chief Manager of Honest Bank, Ms Priyanka, who had been in the trade finance division of the bank for more than a decade and had successfully completed certificate courses in Trade Finance from one of the premium institutes of India. Nitin: Good morning maam. How are you doing? Priyanka: I Am good. How about you? How was the performance of your company last year? Nitin: We did a turnover of INR50 crore last year which was a 30 per cent jump over the previous year. This year, we are expecting the sales to be up by a further 40 per cent. In fact, we have just received a few large orders from the USA and the EU. Figure 1 Trend of exports of textile and clothing from 2010-2011 to 2013-2014 0 50,000 100,000 150,000 200,000 250,000 2010-11 2011-12 2012-13 2013-14 Exports Year INR Crore USD Mn Source: Ministry of textiles, available at: http://texmin.nic.in/ sector/note_on_indian_textile_and_clothing_exports_intl_trade _section_Anx_I.pdf (accessed 24 January 2015) Figure 2 Process of letter of credit Importer LC Issuing Bank LC Advising Bank Exporter 1. Purchase Order 2. Approaches LC issuing Bank for Issuance 3. LC Issued and transm ed 4. LC advised 5. Shipment of Goods 6. LC, dra and shipping documents 7. LC, dra and shipping documents presented 8. Payment 9. Payment 10. Shipping documents forwarded 11. Payment PAGE 2 EMERALD EMERGING MARKETS CASE STUDIES VOL. 5 NO. 4 2015 Downloaded by Swinburne University of Technology At 06:42 27 March 2017 (PT) Priyanka: That is good to hear. Tell me, how can we assist you? Narayan: Over the years, the company has grown steadily and Nitin has been able to manage the growing fund requirement from his own funds and profits. Now that the company has reached a considerable size, we are looking to borrow funds from the bank to finance the international trade and enhance liquidity position of the company. Priyanka: We would be glad to get associated with your reputed organisation by financing your requirement. Nitin: What are the different ways in which you can extend loan to us? Priyanka: We can extend a line of credit to you to finance your export business. This could include availing pre-shipment finance against a confirmed order. You may utilise these funds for procurement of raw material, labour costs and packaging. Once the goods are shipped, we can extend post-shipment finance by purchasing the drafts and discounting the bill of exchange. Are there also exports that are backed by Letter of Credit (LCs)? Narayan: Our payment terms are for Letter of Credit (LCs), we receive LCs from buyers in the USA which are issued by top 10 banks of the world. Generally, the LC terms are for 180-day issuance from date of shipment. This leads to a temporary shortage of funds as we have already incurred the expenses for producing the goods and arranging to ship them; however, the payment from the importer becomes due on a later date. Priyanka: In such a case, on receipt and acceptance of an LC from a reputed bank, we can extend funds to you in anticipation of funds on the due date. Nitin: We are planning to import some machinery from Germany. Since the seller has a monopoly in the industry, they are insisting that we send them an advance before they ship the machinery to us. Priyanka: We can issue a Letter of Credit on your behalf in favour of the overseas supplier. Once the goods are shipped, the seller will present the documents including the Invoice, Insurance Policy, Packing List, Certificate of Origin, Bill of Exchange and Transport Documents for checking. Once we ascertain that the documents are as per the terms of the Letter of Credit, we will make payment to the overseas buyer. You can further avail buyers credit for making payment to the supplier. To understand the complete process of a Letter of Credit, please have a look at the below Figure 2. Narayan: What is the significance of these documents? Priyanka: The Commercial Invoice provides the details of goods shipped, along with the description of goods and their prices as agreed between the buyer and seller. An Insurance Policy is evidence of a contract of insurance and shows the full details of risks covered. A Packing List gives the details of the material packed. A Certificate of Origin is a proof that the goods originated in a particular country. A Bill of Exchange is a demand for payment issued by the exporter (drawer) to the importer (drawee). Narayan: Thanks, maam, for your guidance. Let me speak to the supplier and urge him to accept a Letter of Credit in place of an advance payment. Is there any other way in which you can support us? Priyanka: Yes, we can extend Bank Guarantees on your behalf as and when required. I would request you to share with me a copy of the latest audited balance sheet and a few details so that we can go ahead with the credit appraisal. This would involve assessing the balance sheet of your company. Nitin: Thanks, Priyanka for taking out time for meeting us. Let me discuss your proposal with our team and get back to you. Priyanka leaves Nitin: Narayan, would you recommend availing finance from the bank? VOL. 5 NO. 4 2015 EMERALD EMERGING MARKETS CASE STUDIES PAGE 3 Downloaded by Swinburne University of Technology At 06:42 27 March 2017 (PT) Narayan: I have scheduled a meeting with a factoring agency. Let us explore all the options and decide after that. Meeting with the factoring agency Nitin and Narayan decide to meet Mr Kapil, the head of Reliable Factors Ltd. Kapil has been working with Reliable Factors for more than 15 years. Kapil: Welcome Nitin and Narayan. I am obliged to meet you. I have heard many good things about your organisation at trade body meetings. Nitin: We are pleased to know this. We set up this company 10 years ago with a modest promoter funding of INR1 million, and last year we reached a turnover of INR500 million. Kapil: That is great to hear. Tell me, how I can be of assistance to you? Narayan: We are projecting a 40 per cent growth in turnover for which we are looking at a factoring agency which can fund our exports and streamline our cash flows. Kapil: We have been in the business of factoring for the past 15 years and have a sizeable portfolio in the textile sector. You can sell the export receivables to us in exchange of cash. Nitin: We would like to understand the process involved in the factoring of our exports. Kapil: We will sign a written agreement with you. Whenever you receive an order from the buyer, please let us know and we will do an examination of the creditworthiness of the buyer through our correspondent import factor based in the country of the buyer. Once this is done, you can ship the goods to the buyer. You can assign the invoices in our favour and we will provide a pre-agreed amount of cash in return. We will follow-up with the buyer for payment and the buyer will make the full payment to us. Narayan: What if the payment doesnt come from the buyer on the due date? Kapil: There are two types of factoring: factoring with recourse, wherein, we will recover funds from you if the overseas buyer defaults and factoring without recourse, wherein, we will assume the payment risk of the overseas buyer and hence it is costlier than the first option. Nitin: What would be the charges for your services? Kapil: We usually charge interest in addition to the factoring commission which ranges between 1 and 3 per cent of the total transaction value depending on the credit standing of the buyer and buyers country. Narayan: Is there any additional service that you can offer to us? Kapil: In addition to providing financing, we can also perform credit investigations, guarantee commercial and political risks, assume collection responsibilities and offer marketing assistance. We can also look at doing forfaiting in case of medium- to long-term receivables. Ntitin: How is forfaiting different from factoring? Kapil: While factoring is used to finance short-term receivables ranging from 90 to 180 days, forfaiting is more relevant to capital goods and is used to finance medium- to long-term receivables, i.e. from 180 days up to 7 years. The financial instruments in forfaiting are usually time draft, bills of exchange and promissory notes. Forfaiting is always without recourse. Narayan: How does forfaiting work? Kapil: Forfaiting involves four parties the exporter, the forfeiter, the importer and a bank from the importing country. Once the exporter manufactures the goods and sells them to the importer, the importer accepts Bills of Exchange drawn in its favour or issues promissory notes to the exporter. These financial instruments are guaranteed by a bank in PAGE 4 EMERALD EMERGING MARKETS CASE STUDIES VOL. 5 NO. 4 2015 Downloaded by Swinburne University of Technology At 06:42 27 March 2017 (PT) the importers country usually on an irrevocable basis. On receipt of these financial instruments, the forfeiter extends funds to the exporter. Nitin: Is there any difference in the pricing of factoring and forfaiting? Kapil: Since forfaiting is always without recourse, it is more expensive than factoring. In the case of forfaiting, a commitment fees is taken by us in addition to the discount fees for our commitment to execute a specific forfaiting transaction at a firm discount rate within a specified time. It varies between 0.5 to 1.5 per cent per annum of the unutilized amount to be forfeited and is charged for the period between the date the commitment is given and the date the discounting takes place or until the validity of the contract, whichever is earlier. Nitin: It was nice meeting you. We will share with you a list of the buyers, countrywise, that we deal with. Please let us know your tentative pricing for both factoring and forfaiting. Kapil leaves Nitin: What do you think about the proposal for factoring and forfaiting? Narayan: Let us also visit the Web site of Exim Bank, India, and Export Credit Guarantee Corporation of India Ltd. (ECGC). Export import Bank of India Exim Bank is the premier export finance institution of India. It was set up in 1982 under the Export Import Bank of India Act 1981, and the governments objective behind it was to enhance exports from India and integrate the countrys foreign trade and investment with the overall economic growth. In 2014, the bank had a loan portfolio of INR745,983 million [www.eximbankindia.in/ (accessed 10 August 2014)]. The bank plays an important part in Indias trade by financing, promoting and facilitating Indias foreign trade and is the principal financial institution in the country for coordinating the working of institutions engaged in financing exports and imports. The Exim Bank has taken the following initiatives to promote Indias foreign trade: Project exports: Exim Bank takes funded (Pre-Shipment Credit, Post-Shipment Credit, etc.) and non-funded exposure (Guarantee) for supporting turnkey projects, civil construction contracts, technical and consultancy service contracts, as well as supplies. Overseas investment finance program: The bank encourages Indian companies to invest abroad by providing facilities for Indian investments and overseas acquisitions. These facilities include loans to Indian Companies for investing in overseas ventures, extending letters of credit and guarantees to facilitate local borrowings by the overseas ventures. Lines of credit: Exim Bank extends Lines of Credit (LOC) to foreign governments or their nominated agencies and overseas financial institutions enabling them to finance imports of goods and services from India on deferred credit terms and thus promoting exports from India to target countries. Buyers credit: Overseas buyers can avail this facility for import of goods and services from India on deferred payment terms. This facility enables overseas buyers to avail medium- to long-term financing at a low cost compared to high cost of funding in the country of the importer. Marketing advisory services: Exim Bank supports Indian companies in their marketing initiatives on a success fees basis. The bank assists in identification of overseas opportunities for finding new markets, setting up plants and acquisition of overseas companies. VOL. 5 NO. 4 2015 EMERALD EMERGING MARKETS CASE STUDIES PAGE 5 Downloaded by Swinburne University of Technology At 06:42 27 March 2017 (PT) Corporate banking: The bank offers Term Loans in Indian Rupees/Foreign Currency to Indian Exporters, Export-Oriented Units (EOUs), Micro Small and Medium Enterprises (MSMEs) for financing projects, R&D, Expansion, working capital and modernisation. Grassroots initiatives and development (GRID) programme: Under this programme, EXIM Bank extends financial support to create export capability in grassroots enterprises and promote grassroots initiatives and technologies having export potential. Additionally, they also discussed getting the foreign credit insurance offered by the Export Credit Guarantee Corporation of India Ltd. backed by the government of the country to cover all kinds of risks associated with export trading, e.g. loss of money on account of foreign buyer becoming bankrupt or sudden import or exchange restrictions resulting in stopping of payments [www.ecgcindia.in/en/pages/ecgcaphome.aspx (accessed 10 August 2014)]. Currency risk While deciding on the strategy for the coming year, Nitin is also faced with the challenge on how to mitigate the currency risk. In the past, there have been instances where Nitin has quoted the price at the prevalent currency rate and by the time the export proceeds were realised, he received a lesser value for his goods. Nitin extracted the data of Foreign Exchange Rates for the past year and, on analysis, found that there had been an average 5-7 per cent fluctuation in the foreign currency rates against the Indian Rupee on a daily basis. Nitin was unable to decide whether to hedge the foreign currency or not (Figure 3). Narayan advised Nitin that there were two ways of hedging the currency risk: 1. A forward contract between a bank and a customer calls for a delivery, at a fixed future date, of a specified amount of one currency against another currency at an exchange rate fixed at a time the contract is entered into. 2. An option is a financial instrument that gives the holder the right but not the obligation to sell or buy another financial instrument at a set price and expiration date (Shapiro, 2006). Equipped with the knowledge of different ways of financing the foreign trade and hedging the currency risk, Nitin and Narayan decided to hold a meeting next day with the management team to discuss their views on how to meet their growing requirement of capital and boost the liquidity position of the company. They needed to make a decision Figure 3 Foreign currency rates with respect to Indian rupee from 1 April 2014 to 31 March 2014 0 20 40 60 80 100 120 02-04-13 02-05-13 02-06-13 02-07-13 02-08-13 02-09-13 02-10-13 02-11-13 02-12-13 02-01-14 02-02-14 02-03-14 FX rate Date Foreign Exchange Rates for FY 14 USD GBP EURO Source: www.rbi.org.in PAGE 6 EMERALD EMERGING MARKETS CASE STUDIES VOL. 5 NO. 4 2015 Downloaded by Swinburne University of Technology At 06:42 27 March 2017 (PT) immediately as the peak season was approaching and they needed funds immediately to start working on the orders they had received. Narayan summarised the following list of products discussed during the different meetings for the ease of decision-making: 1. Bank: Pre-shipment finance; Post-Shipment Finance; Discounting against Letter of Credit; Letter of Credit; Buyers Credit; and Bank Guarantee. 2. Factoring Agency: Factoring with recourse; Factoring without recourse; Credit investigations; Guarantee commercial and political risks; Collection responsibilities; Marketing assistance; and Forfaiting. 3. Export Import Bank of India: Project Exports; Overseas Investment Finance Program; Lines of Credit (LOC); Buyers Credit; Marketing Advisory Services; Corporate Banking; and Grassroots Initiatives & Development (GRID) programme. 4. Export Credit Guarantee Corporation of India: Foreign credit insurance. Reference Shapiro.