TYPES OF RISKS IN INTERNATIONAL TRADE
The various types of risks that an international trader faces are divided into the following categories:
1. Commercial risks
2. Political risks
3. Risks arising out of foreign laws
4. Cargo Risks
5. Credit risks
6. Foreign exchange fluctuations risks.
Now, let us discuss these risks, in detail.
1. Commercial Risks
Causes of Commercial Risks: Commercial risks are caused due to the factors:
(i) Lack of knowledge about the foreign markets:
(ii) Inadaptability of the export product to change to the conditions of the foreign market requirements
(iii) Longer transit time and
(iv) Varying situations to be handled, not anticipated before export.
Nature of Risk different in International Trade
Commercial risks exist in domestic market too. But, their impact in international market: is greater, in comparison. to domestic market. The changes in international market are hazardous and difficult to anticipate. Suitability and acceptability of the product international market is rather difficult to gauge. Variations in demand and supply conditions are more unpredictable.
Most of the commercial risk s are to he borne by the exporters. Exporters cannot shift these risks to the professional risk bearers, paying insurance premium. The exporter is not, aware of the conditions in the foreign market as the way he is aware of domestic market. Long distances to travel along with cost and time implications distinguish international trade from domestic trade. Exporter cannot visit Paris with the same ease he does Mumbai from Bhopal. If goods are not sold or price realization is lower than anticipated, due to changes in demand or supply, exporter has to bring back the goods, incurring additional freight cost or opt to sell the goods at a loss.
In international. market, as in domestic market, presence of competitors influences the demand and supply conditions and entry of new competitors depresses the market more. Further, local production may bring down the prices. Introduction of substitutes to capture the market may take away the exporter's share in the market.
The price realization of the product in export market is influenced by:
(a) Changes in Exchange Rates: Changes in home currency or foreign currency affects the price realization. If the home currency is devalued, the competitive capacity' of the exporter is enhanced. If the foreign currency is depreciated, there is ; considerable reduction in the exporter's competitive strength.
(b) Changes in import Duties or Tariff Barriers: Changes in import duties and creation of tariff barriers disturb even an established market. In this field, through the efforts of GATT, import duties have been fairly reduced and market has become stable. On account of these impediments, exporters open manufacturing facilities in the importing countries to overcome these problems.
(C) Changes in Transport costs: Transport costs constitute, generally, a major part the invoice value and so any change in transport costs affects the competitive edge of the exporter. Change in transport costs does not affect FOB price., There, is no problem even in CIF contracts, which have escalating clause in respect of transport costs. Exports Have to worry in CIF contracts, which have escalating clause in respect of transport costs have to worry in case of CIF contracts that are net with escalation clause:
d) Change in Foreign Market Characteristics: A classical example is change in styles soon after shipment of goods in particular, when the shipment is made without letter of credit , ready made garments suffer, greatly from this problem.
Minimization of Commercial Risks: Commercial risks can be minimized by using forecasting techniques and keeping a careful watch on the changing business conditions in the concerned country, in particular, and also keeping a track of the changes in the world economy. Exporters have to be prepared to face any eventuality and wisdom lies in forecasti,44 and anticipating, of course, finally, quick responding, at the earliest hour.
2. Political Risks change in These risks arise due to change in political situations in the concerned importing and exporting countries. Following are the factors, affecting the political situation:
(i) Changes in the party in power in the concerned countries, followed by 1 head of the Government;
(ii) Coups, civil wars and rebellions:
(iii) Wars between the countries or among- many countries and
(iv) Capture of cargo by enemies during war.
Political Asks can be avoided, to a certain extent, by judicious selection of the countries to which goods are exported. Insurance companies may agree to provide cover for some of these risks, by collecting additional premium. Export Credit. Guarantee Corporation (ECGC.) also 'covers seine of the risks.
3. Risks Arising out of Foreign Laws (Legal Risks) Every country has its own commercial law. So, different laws prevail both in exporter and importer countries. Legal proceedings are complex as well as expensive. In every relationship, however cordial and long-standing may be, differences are likely to arise. Legal risks can be avoided to a great extent by incorporating the provision for appointment of an arbitrator, in case of dispute about contractual terms.
4. Cargo risks Transportation of cargo has undergone radical improvements over a period. Most of the goods are transported by sea. Transit risks are a common hazard for those engaged in export/import business. The list of dreary and hazardous risks in transit is long viz. Storms, collisions, theft, leakage, explosion, spoilage, fire, and high sea robbery. Every exporter should have working knowledge of marine insurance so that he knows whether he is getting the required risk protection at the minimum cost, It is always possible to transfer the financial losses resulting from perils of sea and perils in transit to professional risk bearers known as underwriters Principles of marine insurance are also equally applicable to insurance of air cargo also.
5. Credit Risks, Risks are inherent in credit transactions; more so in international business. International business is invariably riskier than the domestic trade. Credit risk. is not the same whether one sells the goods in domestic market or in foreign market. Success, in international business depends, largely, on the ability of the exporters to give credit to importers on tree competitive and favorable terms.
Export business has become highly risky as selling on credit has become very common. Importers are sought after so it is but natural they dictate terms as there are many exporters competing for the cake of international trade. Insolvency rate is on the increase. Balance of payment difficulties has severely affected the capacity of many countries to pay the import price. However, offering credit has become unavoidable to the exporters to face competition. Two issues stand before the exporters:
(i) The exporter must have sufficient funds to offer credit to the buyers abroad and
(ii) The exporter should be prepared to take credit risks.
Meaning of Credit Risk
Once goods are sold on credit risks arising in realizing the sale proceeds are referred as credit risks. Risk may arise due to inability of the buyers to pay on the due date. Alternatively, even if the buyer makes the payment, situations may change in the buyer's country that the funds of 'buyer do not reach the exporter. An outbreak of war, civil war, coup or an insurrection may block or delay the payment for goods exported. Whatever the reason may be, if funds are not received, sufferer is, finally, exporter. Credit risk has assumed an alarming proportion on account of large volumes in international business and sweeping changes in political and economic conditions, globally. In such a high risky situation, credit risk insurance is of immense help to the exporters as well as banks that finance the exporters.
Organization covering Credit Risk
There are more than 40 organizations covering the credit risk, all the world over. In India, we have Export Credit Guarantee Corporation of India Limited to cover export credit risks. This is a Government of India enterprise, with its Head office located in Mumbai, under the administrative control of the Ministry of Commerce. Board of Directors representing Government, Banking, Insurance, Trade and Industry manages this organization.
Types of Cover issued by ECGC: They are broadly divided into four groups:
I Standard Policies: They are ideally suitable to exporters to cover payment risks involved in exports on short-term credit basis.
2. Specific Policies: These policies are specifically designed to protect Indian exporters from the risks involved in
(a) Exports on deferred payment contracts
(b) Services rendered to foreign parties and
e) Construction works and turnkey projects undertaken abroad.
Special Policies, beside the risks covered under Standard policies, are issued 1-, - ECGC to meet the specific requirements of export transactions.
3. Financial Guarantee: They are the policies issued to banks for covering risks in extending credit at pre-shipment as well as post shipment stages.
4. Special Schemes: They are meant to cover risks involved in confirmation to letters of credit opened by foreign banks, insurance cover for buyers credit,, line of credit and exchange fluctuations risks.
Standard policies: The ECGC has designed four types of standard policies for shipment made on short-term credit.
(a) Shipments (Comprehensive Risks) I OCY This covers from commercial and political risks from the date of shipment.
(b) Shipments (Politico Risks): This covers from political risks from the date of shipment.
(e) Contracts (Comprehensive Risks) Policy: This covers from commercial and political risks from the date of contract.
(d) Contracts (Political Risks) Policy: This covers from political risks from the date of contract.
The Shipments (Comprehensive Risks) policy is the one ideally suitable for goods exported on short-term credit basis. This policy covers from commercial and political risks from the date of shipment. Risk of pre-shipment losses on account of frustration of contract are practically nil in respect of export of raw materials, consumer durable or consumer good,: as they can be sold easily. Contract policies cover from the date of contract so they are ideally suitable in case goods are to be manufactured to meet the specific requirement of buyers and do not have alternative buyers. Further, the risk of ban on export of goods is covered by the contract policy only.
Risks Covered under Standard Policies Risks covered by Standard Policies fall into two categories. (A) Commercial Risks: This includes:
(i) insolvency, of the buyer;
(ii) protracted default in payment (Importer has to pay within four months of due date) a
(iii) Under special circumstances specified in the policy, buyer's failure to accept the goods though there is no fault on the part of exporter.
M) Political. Risks: This includes:
('1) imposition of restrictions in buyer's country by the Government for remittance of • sale proceeds which may block or delay the payment to the exporter:
ii) war, revolution or civil disturbances in the buyer's country;
(ill) new import restrictions in the buyer's country or cancellation of valid import licence, after the date of shipment or contract, as applicable
(iv) cancellation of valid export licence or imposition of new licensing restrictions after the date of contract, applicable under Contracts Policy;
(v) payment of additional transportation and insurance charges occasioned by interruption or diversion of voyage which can not be recovered from the buyer and
(vi) Any other loss that has occurred in buyer’s country, which is not covered under general insurance and beyond the control of exporter and / or the buyer
In case where the buyer happens to be foreign government or government department and it refuses to pay, the default will fall under the category of political risks
Risks Not Covered : The standard policies do not cover the following risks.
1. Commercial disputes including the quality disputes raised by the buyer , unless the exporter obtains a decree from a competent court I the importer country in his favour
2. Causes inherent in the nature of the goods,
3. Buyer’s failure to obtain import license or exchange authorization in his country
4. Insolvency or default of an agent of the exporter or the collection banks
5. Losses or damages which can be covered by commercial insurers; and
6. Exchange fluctuations
ECGC does not cover those risks that are covered by the commercial insurers. Exporter Can take comprehensive policy that covers both commercial and political risks. If the exporter want , he can take only policy that covers political risks, depending on the requirements. How ever, it is important to note ECOC does not issue the policy covering only commercial risks.
lf the goods are confiscated by the customs on charges of smuggling, then insurance does not cover
6, Foreign Exchange Fluctuations Risks
If the exporter has invoiced in the buyer's currency, he will be subjected to risk of foreign exchange fluctuations. If the foreign currency depreciates in terms of rupees, exporter will receive lesser amount in terms of rupees or vice versa. In the same circumstances, if the Indian currency depreciates, exporter stands to gain. If the export, bill is purchased or negotiated under letter of credit and the foreign currency undergoes fluctuation, the bank will be bearing the risk. However, if the exporter has sent the bill for collection, the exchange rate on the date of receipt of foreign currency in India will be given to the exporter. If there is intervening difference in the exchange rate between the date of giving the bill for collection and date of realization, exporter stands to lose or gain, depending on the trend in fluctuation.
There will be no foreign exchange risk in case the invoice is made in Indian rupees. In such a case, the importer will be subjected to foreign exchange fluctuation risk.
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