Trade Settlement and Export Finance Methods

Unit 4: Trade Settlement Methods, Export
Finance, International Sources of Finance
International Finance

Trade Settlement Methods
2 Mrs. Charu Rastogi, Asst. Professor

Methods of payment in international trade
 To succeed in today‟s global marketplace and win
sales against International trade presents a spectrum
of risk, which causes uncertainty over the timing of
payments between the exporter (seller) and importer
(foreign buyer).
 For exporters, any sale is a gift until payment is
received.
 Therefore, exporters want to receive payment as soon
as possible, preferably as soon as an order is placed
or before the goods are sent to the importer.
 For importers, any payment is a donation until the
goods are received.
 Therefore, importers want to receive the goods as
soon as possible but to delay payment as long as
possible, preferably until after the goods are resold to
generate enough income to pay the exporter.3 Mrs. Charu Rastogi, Asst. Professor

Methods of payment in international trade :
Cash in Advance / Prepayments
 With cash-in-advance payment terms, the exporter
can avoid credit risk because payment is received
before the ownership of the goods is transferred.
 Wire transfers and credit cards are the most
commonly used cash-in-advance options available to
exporters.
 However, requiring payment in advance is the least
attractive option for the buyer, because it creates
cash-flow problems. Foreign buyers are also
concerned that the goods may not be sent if payment
is made in advance.
 Thus, exporters who insist on this payment method as
their sole manner of doing business may lose to
competitors who offer more attractive payment terms.

Methods of payment in international trade:
Letters of Credit
 Letters of credit (LCs) are one of the most secure
instruments available to international traders.
 An LC is a commitment by a bank on behalf of the
buyer that payment will be made to the
exporter, provided that the terms and conditions
stated in the LC have been met, as verified through
the presentation of all required documents.
 The buyer pays his or her bank to render this service.
 An LC is useful when reliable credit information about
a foreign buyer is difficult to obtain, but the exporter is
satisfied with the creditworthiness of the buyer‟s
foreign bank.
 An LC also protects the buyer because no payment
obligation arises until the goods have been shipped or
delivered as promised.

Letter of credit: Procedure
Buyer (Importer) Seller (Exporter)
Exporter‟s bank
(Advising Bank)
Importer‟s bank
(Issuing Bank)
1. Sale Contract
3. Send Credit
4. Deliver Letter
of Credit
2. Request
for Credit
5. Deliver Goods
7. Present Documents
6. Present
Documents
8. Documents
and claim for
payments

Types of Letter of Credit
 Irrevocable and revocable letters of credit
 A revocable letter of credit can be changed or cancelled by the bank that issued it
at any time and for any reason.
 An irrevocable letter of credit cannot be changed or cancelled unless everyone
involved agrees. Irrevocable letters of credit provide more security than revocable
ones.
 Confirmed and unconfirmed/Advised letters of credit
 When a buyer arranges a letter of credit they usually do so with their own bank,
known as the issuing bank. The seller will usually want a bank in their country to
check that the letter of credit is valid.
 For extra security, the seller may require the letter of credit to be 'confirmed' by the
bank that checks it. By confirming the letter of credit, the second bank agrees to
guarantee payment even if the issuing bank fails to make it. So a confirmed letter of
credit provides more security than an unconfirmed one.
 In case of unconfirmed LC, the advising bank forwards an unconfirmed letter of
credit directly to the exporter without adding its own undertaking to make payment
or accept responsibility for payment at a future date, but confirming its authenticity.

 Transferable letters of credit
 A transferable letter of credit can be passed from one
'beneficiary' (person receiving payment) to others. They're
commonly used when intermediaries are involved in a
transaction.
 Stand-by LC
 A standby letter of credit is like a guarantee that is used as
support where an alternative, less secure, method of payment
has been agreed.
 It is an assurance from a bank that a buyer is able to pay a
seller. The seller doesn't expect to have to draw on the letter of
credit to get paid.

 Revolving LC
 The revolving credit is used for regular shipments of the same commodity to the
same importer. It can revolve in relation to time or value. If the credit is utilised it is
re-instated for further regular shipments until the credit is fully drawn. If the credit
revolves in relation to value once utilised and paid the value can be reinstated for
further drawings.
 Revolving letters of credit are useful to avoid the need for repetitious arrangements
for opening or amending letters of credit.
 Back to Back LC
 A back-to-back letter of credit can be used as an alternative to the
transferable letter of credit. Rather than transferring the original letter of credit
to the supplier, once the letter of credit is received by the exporter from the
opening bank, that letter of credit is used as security to establish a second
letter of credit drawn on the exporter in favour of his importer.
 Many banks are reluctant to issue back-to-back letters of credit due to the
level of risk to which they are exposed, whereas a transferable credit will not
expose them to higher risk than under the original credit.

Documentary Collections/Drafts/Bills of Exchange)
 A documentary collection (D/C) is a transaction whereby
the exporter entrusts the collection of a payment to the
remitting bank (exporter‟s bank), which sends documents
to a collecting bank (importer‟s bank), along with
instructions for payment.
 Funds are received from the importer and remitted to the
exporter through the banks involved in the collection in
exchange for those documents.
 D/Cs involve using a draft that requires the importer to pay
the face amount either at sight (document against
payment) or on a specified date (document against
acceptance).
 The draft gives instructions that specify the documents
required for the transfer of title to the goods. Although
banks do act as facilitators for their clients, D/Cs offer no
verification process and limited recourse in the event of
non-payment.
 Drafts are generally less expensive than LCs.10 Mrs. Charu Rastogi, Asst. Professor

Open Account
 An open account transaction is a sale where the goods are
shipped and delivered before payment is due, which is
usually in 30 to 90 days.
 Obviously, this option is the most advantageous option to
the importer in terms of cash flow and cost, but it is
consequently the highest risk option for an exporter.
 Because of intense competition in export markets, foreign
buyers often press exporters for open account terms since
the extension of credit by the seller to the buyer is more
common abroad. Therefore, exporters who are reluctant to
extend credit may lose a sale to their competitors.
 However, the exporter can offer competitive open account
terms while substantially mitigating the risk of non-payment
by using of one or more of the appropriate trade finance
techniques, such as export credit insurance.

Comparison

Comparison
Cash in
Advance
Letter of Credit DC/BoE Open Account
Time of
Payment
Before
Shipment
When shipment is
made
On presentation of
draft
As agreed
upon
Goods
available to
buyers
After payment After payment After payment
Before
payment
Risk to
exporter
None Very little - None
Disposal of
unpaid goods
Relies on buyer
to pay as
agreed upon
Risk to
importer
Relies on
exporter to
ship goods as
ordered
Assured shipment but
relies on exporter to
ship goods as
described in the
documents
Relies on exporter
to ship goods as
described in the
documents
None

Export Finance

Export Finance Classification
 Export finance can be:
 Pre-shipment finance
 Post shipment finance

 Pre-shipment finance refers to finance extended to purchase,
processing or packing of goods meant for exports.
 Pre-shipment credit also known as „Packing credit”. Packing
credit can also be extended as working capital assistance to
meet expenses such as wages, utility payments, travel expenses
etc; to companies engaged in export or services.
 The main objectives behind pre-shipment finance or pre export
finance is to enable exporter to:
 Procure raw materials.
 Carry out manufacturing process.
 Provide a secure warehouse for goods and raw materials.
 Process and pack the goods.
 Ship the goods to the buyers.
 Meet other financial cost of the business.
Pre-Shipment Finance

Export Finance Methods
 Accounts Receivable Financing
 An exporter that needs funds immediately may obtain a bank loan that is
secured by an assignment of the account receivable
 Factoring (Cross-Border Factoring)
 The accounts receivable are sold to a third party (the factor), that then
assumes all the responsibilities and exposure associated with collecting
from the buyer.
 Letters of Credit (L/C)
 These are issued by a bank on behalf of the importer promising to pay
the exporter upon presentation of the shipping documents.
 The importer pays the issuing bank the amount of the L/C plus
associated fees.
 Commercial or import/export L/Cs are usually irrevocable.
 The required documents typically include a draft (sight or time), a
commercial invoice, and a bill of lading (receipt for shipment).
 Sometimes, the exporter may request that a local bank confirm
(guarantee) the L/C.
 Variations include
 standby L/Cs : funded only if the buyer does not pay the seller as agreed upon
 transferable L/Cs : the first beneficiary can transfer all or part of the original L/C to a
third party
 assignments of proceeds under an L/C : the original beneficiary assigns the proceeds
to the end supplier

Export and Import Finance Methods
 Banker‟s Acceptance (BA)
 This is a time draft that is drawn on and accepted by a bank (the
importer‟s bank). The accepting bank is obliged to pay the holder
of the draft at maturity.
 If the exporter does not want to wait for payment, it can request
that the BA be sold in the money market. Trade financing is
provided by the holder of the BA.
 The bank accepting the drafts charges an all-in-rate (interest rate)
that consists of the discount rate plus the acceptance
commission.
 In general, all-in-rates are lower than bank loan rates. They
usually fall between the rates of short-term Treasury bills and
commercial papers.
 Working Capital Financing
 Banks may provide short-term loans that finance the working
capital cycle, from the purchase of inventory until the eventual

Export and Import Finance Methods
 Medium-Term Capital Goods Financing (Forfaiting)
 The importer issues a promissory note to the exporter to
pay for its imported capital goods over a period that
generally ranges from three to seven years.
 The exporter then sells the note, without recourse, to a
bank (the forfaiting bank).
 Countertrade
 These are foreign trade transactions in which the sale of
goods to one country is linked to the purchase or
exchange of goods from that same country.
 Common countertrade types include
barter, compensation (product buy-back), and counter
purchase.
 The primary participants are governments and
multinationals.

Factoring V/s Forfaiting
On going arrangement Single transaction based
Open account sale LC or bank acceptance required
Provides other than financing Primarily a financing service
services
Used for offering short term credit For medium / long term transaction
to regular buyers (up to 180 days) which could be “one-off” (90 days to 7years)
Both with and without recourse Is without recourse
For domestic and export receivables Usually for export receivables
No minimum size Transaction should be minimum USD
100,000

Buyer‟s Credit and Supplier‟s
Credit

Buyer‟s Credit
 A financial arrangement in which a bank or financial
institution, or an export credit agency in the exporting
country, extends a loan directly to a foreign buyer or
to a bank in the importing country to pay for the
purchase of goods and services from the exporting
country.
 This term does not refer to credit extended directly
from the buyer to the seller (for example, through
advance payment for goods and services).
 Buyer‟s Credit also refers to loans for payment of
imports into India arranged on behalf of the importer
through an overseas bank. The offshore branch
credits the nostro of the bank in India and the Indian
bank uses the funds and makes the payment to the
exporter‟ bank as an import bill payment on due date.
The importer reflects the buyers credit as a loan on
the balance sheet.23 Mrs. Charu Rastogi, Asst. Professor

Benefits of Buyer‟s Credit
 The exporter gets paid on due date; whereas importer
gets extended date for making an import payment as
per the cash flows
 The importer can deal with exporter on sight basis,
negotiate a better discount and use the buyers credit
route to avail financing.
 The funding currency can be in any FCY (USD, GBP,
EURO, JPY etc.) depending on the choice of the
customer.
 The importer can use this financing for any form of
trade viz. open account, collections, or LCs.
 The currency of imports can be different from the
funding currency, which enables importers to take a
favourable view of a particular currency.

Buyer‟s Credit Process Flow
 Indian customer imports the goods either under DC / LC, DA /
DP
 Indian customer requests the Buyer‟s Credit Consultant before
the due date of the bill to avail buyers credit finance.
 Consultant approaches overseas bank for indicative
pricing, which is further quoted to Importer.
 If pricing is acceptable to importer, overseas bank issue‟s offer
letter in the name of the Importer.
 Importer approaches his existing bank to get letter of undertaking
/ comfort (LOU / LOC) issued in favour of overseas bank via
swift.
 On receipt of LOU / LOC, Overseas Bank as per instruction
provided in LOU, will either funds existing bank‟s Nostro
account or pays the supplier‟s bank directly
 Existing bank to make import bill payment by utilizing the amount
credited (
 On due date existing bank to recover the principal and Interest
amount from the importer and remit the same to Overseas Bank
on due date.25 Mrs. Charu Rastogi, Asst. Professor

Regulatory Framework
 Amount and Maturity
 Maximum Amount Per transaction : $20 Million
 Maximum Maturity in case of import of non capital goods: upto 1
year from the date of shipment
 Maximum Maturity in case of import of capital goods : upto 3
years from the date of shipment
 Maximum Maturity in case of import of capital goods for
companies classified as Infrastructure sector: Upto 5 years from
the date of shipment
 All-in-cost Ceilings
 Upto 1 year : 6 Month Libor + 350 bps
 Upto 3 years : 6 Month Libor + 350 bps
 Upto 5 years: 6 Month Libor + 350 bps
 All applications for short-term credit exceeding $20 million for
any import transaction are to be forwarded to the Chief General
Manager, Exchange Control Department, Reserve Bank of India,
Central Office, External commercial Borrowing (ECB) Division,
Mumbai

Costs Involved
 Foreign bank interest cost
 Foreign Bank LC Confirmation Cost (Case to
Case basis)
 LC advising and or Amendment cost
 Negotiation cost (normally in range of 0.10%)
 Postage and Swift Charges
 Reimbursement Charges
 Cost for the usance (credit) tenure. (Indian Bank
Cost)

Suppliers Credit
 Supplier‟s Credit relates to credit for imports into
India extended by the overseas suppliers or
financial institutions outside India.

Buyer’s Credit Supplier’s Credit
 importer of goods applies
for buyers credit
 buyers credits can be
arranged Sight LC,
Usance LC, DA & DP
excluding Advance
Payment uyers credit
 Buyers Credit quote is
arranged for after opening
of the LC
 Withholding Tax may be
applicable in certain
cases in a buyers credit
but it is not applicable in
suppliers credit.
 Letter of
Undertaking(LOU)
issuance charges are
applicable in case of
 exporter of goods applies for
suppliers credit
 Suppliers credit can only be
arranged against LC backed
transaction
 suppliers credit quote is tied up
before opening of the LC. LC is
then opened as per the terms of
the funding bank in case of
suppliers credit. However, when
the LC is opened before tying
up for the funds in a suppliers
credit, it might need amendment
as per the funding bank.
 suppliers credit is an LC based
transaction, no Letter of
Undertaking(LOU) charges are
applicable.

International Receivables and
Cash Management
Working Capital Management

International Receivables
Management
 Receivables management involves converting
receivables to cash and facilitating :
 Cash flow forecasting
 Long-term funding and investment decisions
 Reduced risk of bad debts
 Stronger liquidity
 Stronger balance sheet ratios

International Cash Management
 Cash management can be broadly defined to
mean optimization of cash flows and
investment of excess cash.
 Cash management refers to the effective
planning, monitoring and management of
liquid / near liquid resources including:
 Day-to-day cash control
 Money at the bank
 Receipts
 Payments
 Short Term investments and borrowings
 Foreign exchange

Cash flows of a subsidiary
Subsidiary
Parent Long term
projects and
investments
Accounts
Payable
Raw
material and
supplies
Inventories
Accounts
receivable
Source of
debt

Centralized cash management
 While each subsidiary is managing its own
working capital, a centralized cash management
group is needed to monitor, and possibly
manage, the parent subsidiary and inter
subsidiary cash
 International cash management can be
segmented into two functions:
 optimizing cash flow movements, and
 investing excess cashflows.

Centralized Cash Flow

Techniques to optimize cash
flows
 Accelerating Cash inflows
 The more quickly the cash inflows are received, the
more quickly they can be invested or used for other
purposes
 Common methods include the establishment of
lockboxes around the world (to reduce mail float) and
preauthorized payments(charging a customer‟s bank
account directly).
 Lockboxes are a service provided by a bank, whereby
the bank receives, processes, and deposits all of a
company's receivables. Lockbox services are sometimes
called 'Remittance Services' or 'Remittance Processing‘
 One benefit of the lockbox service to the commercial customer
is that it can maintain special mailboxes in different locations
around the country and a customer sends payment to the
closest lockbox. The company then authorizes a bank to
check these mailboxes as often as is reasonable, given the
number of payments that will be received. Because the bank is
making the collection, the funds that have been received are
immediately deposited into the company’s account without first

flows
 Minimizing currency conversion costs
 Netting reduces administrative and transaction
costs through the accounting of all transactions that
occur over a period to determine one net payment.
 A bilateral netting system involves transactions
between two units, while a multilateral netting
system usually involves more complex interchanges
 Netting involves settling mutual obligations at the
net value of a contract as opposed to its gross
dollar value. It leads to reducing the transfer of
funds between subsidiaries to a net amount.

flows
 Managing blocked funds
 A government may require that funds remain within
the country in order to create jobs and reduce
unemployment.
 An MNC can shift cost-incurring activities (like R&D)
to the host country, adjust the transfer pricing policy
(such that higher fees have to be paid to the
parent), borrow locally rather than from the parent,
etc

flows
 Implementing inter-subsidiary cash transfers
 A subsidiary with excess funds can provide
financing by paying for its supplies earlier than is
necessary. This technique is called leading.
 Alternatively, a subsidiary in need of funds can be
allowed to lag its payments. This technique is called
lagging.

Complications in Optimizing Cash Flows
 Company related characteristics
 Delay in payment from one subsidiary to another for
supplies received
 Government restrictions
 Prohibition of use of netting
 Restrictions on transfer of cash
 Characteristics of banking systems
 Banking system in advanced countries offer a wider
variety of services
 Non-uniformity of banking systems in different
countries

Investing Excess Cash
 Excess funds can be invested in domestic or foreign short-
term securities, such as Eurocurrency deposits, Treasury
bills, and commercial papers.
 Sometimes, foreign short-term securities have higher
interest rates. However, firms must also account for the
possible exchange rate movements
 Centralized cash management allows for more efficient
usage of funds and possibly higher returns.
 When multiple currencies are involved, a separate pool
may be formed for each currency. Funds can also be
invested in securities that are denominated in the
currencies needed in the future
 Given the current online technology, MNCs should be able
to efficiently create a multinational communications
network among their subsidiaries to ensure that
information about their cash positions is continually
updated

Investing excess cash
 Diversifying Cash Across Currencies
 If an MNC is not sure of how exchange rates will
change over time, it may prefer to diversify its cash
among securities that are denominated in different
currencies.
 The degree to which such a portfolio will reduce risk
depends on the correlations among the currencies
 Use of Dynamic Hedging to Manage Cash
 Dynamic hedging refers to the strategy of hedging
when the currencies held are expected to
depreciate, and not hedging when they are
expected to appreciate.
 •The overall performance is dependent on the firm‟s
ability to accurately forecast the direction of
exchange rate movements

International Sources of Funds
Sources of funds-
•ECBs
•FCCBs
•ADRs
•GDRs
•FDI
•Syndicated Loans

External Commercial Borrowings

Indian Companies can borrow from
sources outside India through:
 ECBs: Bank Loans, Buyer‟s Credit, Supplier‟s Credit,
Securitized instruments (e.g. floating rate notes and fixed
rate bonds)
 Foreign Currency Convertible Bonds (FCCBs)
 Preference Shares (non-convertible or partially/optionally
convertible)
 Foreign Currency Exchangeable Bonds (FCEBs)
 All above instruments are required to conform to RBI‟s
ECB policy norms ECB Policy norms define:
 Automatic or Approval Route
 Eligible Borrowers
 Recognized Lenders
 Amount & All-in cost
 Average Maturity
 End-use Stipulations46 Mrs. Charu Rastogi, Asst. Professor

Need for ECB
 Underdeveloped and the developing economies
require external assistance due to the shortage of
capital within the country.
 The saving generated by the citizens and tax
revenues collected by the government of capital are
too meager compared to the funds requirement for
the development of the infrastructure sector, the
industry and various other developmental activities .
 Scarcity of foreign exchange also plays an important
role as most of the developing economies are
characterized by an adverse balance of payment .
Generally the country‟s exports are not sufficient to
cover the large imports of machinery, components
,spare parts, materials, and related services.
 The government of these economies, therefore,
generally encourage the inflow of external funds into
the country47 Mrs. Charu Rastogi, Asst. Professor

 Under the ECB window, companies in India are
allowed to borrow from overseas, under certain
conditions, through different instruments.
 The Reserve Bank of India (RBI), in its master
circular on external commercial borrowing and
trade credits (January 2012), defined ECB as
“commercial loans in the form of bank loans,
buyers‟ credit, suppliers‟ credit, securitized
instruments (e.g. floating rate notes and fixed rate
bonds, non-convertible, optionally convertible or
partially convertible preference shares) availed of
from non-resident lenders with a minimum
average maturity of three years”.48 Mrs. Charu Rastogi, Asst. Professor

 ECB is allowed through both direct and approval
routes. Under the direct route, companies in
businesses, such as hotel, hospitals and
software, can access the international market for
raising debt up to a limit.
 Special economic zones and non-government
organizations engaged in micro finance activities
are also allowed to access the ECB window.
 Companies of industries that can apply through
the direct route can also take the approval route if
they need to borrow more than the allowed limit
under the direct route.

Forms of External Commercial
Borrowings
 ECB may be in the form of:
 Commercial bank loans
 Buyers‟ credit
 Suppliers‟ credit
 Securitized instruments
 Credit from official sector, e.g., window of multilateral
financial institutions, such as International Finance
Corporation (Washington),
 Various forms of Euro bonds and syndicated loans

Automatic Route
 Amount
 Corporates in Industrial Sector or Infrastructure Sector-USD
750 mn per annum
 Corporates in specified Service Sector-USD 200 mn per
annum
 Maturity
 ECBs up to USD 20 million – 3 years
 ECBs between USD 20 million and USD 750 million –5 years
 Eligible Borrowers
 Corporates in manufacturing sector, infrastructure sector and
service companies in the hotel, hospital, software sectors
(registered under the Companies Act, 1956)
 Infrastructure Finance Companies (IFCs).
 Units in Special Economic Zones( SEZ)
 NGOs engaged in micro finance activities
 Micro Finance Institutions (MFIs).

Automatic Route
 Eligible lenders
 International banks,
 International capital markets,
 Multilateral financial institutions (such as IFC, ADB, etc.)
 Export credit agencies,
 Suppliers of equipments,
 Foreign collaborators and
 Foreign equity holders.
 A "foreign equity holder" to be eligible as “recognized lender”
under the automatic route would require minimum holding of
paid-up equity in the borrower company as set out below:
 For ECB up to USD 5 million - minimum paid-up equity of 25 per
cent held directly by the lender,
 For ECB more than USD 5 million - minimum paid-up equity of
25 per cent held directly by the lender and ECB liability-equity
ratio not exceeding 4:1

Automatic Route : End use
 ECBs are supposed to be utilized for meeting foreign
exchange cost of capital goods and services and also
for project-related rupee expenditure up to certain
limits
 The end use to which funds can be put can be
categorized into:
 Forex cost of capital goods and services
 For project-related rupee expenditure in infrastructure
projects in power, telecom, and railways
 For telecom sector license fee, payments are approved
use of ECB
 For project-related rupee expenditure subject to terms
and conditions specified in schemes
 Not to be used in investment in stock markets and
speculation in real estate53 Mrs. Charu Rastogi, Asst. Professor

Approval Route
 Eligible borrowers
 Borrowers in eligible in automatic category
intending to raise more than the amount allowed
under Automatic Route
 Service sector units, other than those in hotels,
hospitals and software, subject to the condition that
the loan is obtained from foreign equity holders.
 Corporates which are under investigation by the
Reserve Bank and / or Directorate of Enforcement.
 Developers of National Manufacturing Investment
Zones (NMIZs) can avail of ECB for providing
infrastructure facilities within NMIZs.,

Approval Route
 Eligible borrowers
 Cases falling outside the purview of the automatic route
limit
 ECB with minimum average maturity of 5 years by Non-
Banking Financial Companies (NBFCs) for leasing to
infrastructure projects.
 Infrastructure Finance Companies (IFCs) beyond 50 per
cent of their owned funds, for on-lending to the
infrastructure sector as defined under the ECB policy.
 Foreign Currency Convertible Bonds (FCCBs) by
Housing Finance Companies satisfying the following
minimum criteria: (i) the minimum net worth not be less
than Rs. 500 crore, (ii) a listing on the BSE or NSE, (iii)
minimum size of FCCB is USD 100 million and Multi-
State Co-operative Societies engaged in manufacturing

Approval Route
 Additional end use permitted under approval route
 Repayment of Rupee loans availed from domestic
banking system
 Companies which are in the infrastructure sector(except power
companies), as defined under the extant ECB guidelines , are
permitted to utilise 25 per cent of the fresh ECB raised by
them towards refinancing of the Rupee loan/s availed by them
from the domestic banking system.
 Power companies are allowed to utilize 40% of the fresh ECB
for repayment of Rupee
 Loans availed form domestic banks.
 Bridge Finance
 Companies which are in the infrastructure sector, are permitted
to import capital goods by availing of short term credit
(including buyers‟ / suppliers‟ credit) in the nature of 'bridge
finance„. The bridge finance can be replaced with a long term
ECB.

Approval Route
 Additional end use permitted under approval
route
 Refinancing of Rupee loans raised by Telecom
companies to pay spectrum allocation fees.
 Working capital for aviation sector
 Repayment of Rupee loans and/or fresh Rupee
capital expenditure for companies with forex
earnings
 Take out Financing
 Companies in infrastructure project should have a tripartite
agreement with domestic banks and overseas recognized
lenders for either conditional or unconditional take-out of the
loan within three years of the scheduled Commercial
Operation Date (COD). The scheduled date of occurrence57 Mrs. Charu Rastogi, Asst. Professor

Benefits of ECBs
 ECBs are very economical source of raising funds,
since the interest rate is far less as compared to the
interest rate on the debt raised in India.
 ECBs provide foreign currency funds to the corporate
sector that are necessary for import of capital goods
etc.
 There is no need for credit rating. Moreover, ECBs
carry fewer covenants as compared to the debt raised
from Financial Institutions/Banks in India.
 Helps broad base borrowers
 Larger amounts can be raised

The down side of ECBs
 The borrower can be in trouble if the position is not
hedged properly and the currency depreciates
sharply, which will lead to increase in the company‟s
liability.
 Also, at the macro level, higher level of borrowing
from overseas may push the currency to
appreciate, which makes exports uncompetitive in the
international market.
 Access to overseas market and cheaper credit is an
advantage for bigger companies that can borrow
abroad, while smaller companies have to deal with
higher cost of capital in the domestic market.
 Dependence of the country on short-term debt
flow, such as ECB, is rising to fund the current
account deficit and can have negative consequences.

FCCBs

Foreign Currency Convertible Bonds
 FCCB is a quasi-debt instrument that is issued in a
currency different the issuer‟s domestic currency with
options to either redeem it at maturity or convert it into
issuing company‟s stock
 It gives two options. One is, to get the regular interest and
principal and the other is to convert the bond in to equities.
It is a hybrid between bond and stock
 In other words, the money being raised by the issuing
company is in the form of a foreign currency.
 A convertible bond is a mix between a debt and equity
instrument.
 It acts like a bond by making regular coupon and principal
payments, but these bonds also give the bondholder the
option to convert the bond into stock.61 Mrs. Charu Rastogi, Asst. Professor

Foreign Currency Convertible Bonds
 They carry a fixed interest or coupon rate and are
convertible into a certain number of ordinary shares at
a preferred price
 They are convertible into ordinary shares of the
issuing company either in whole, or in part, on the
basis of any equity-related warrants attached to the
debt instruments.
 These bonds are listed and traded abroad. Till
conversion, the company has to pay interest in dollars
, and if the conversion option is not exercised, the
redemption is also made in dollars.
 Thus, foreign investors prefer convertible bonds
whereas Indian companies prefer to issue GDRs.62 Mrs. Charu Rastogi, Asst. Professor

Process of Issuing FCCB
 Obtain prior permission of the Department of
Economic Affairs, Ministry of Finance, Government of
India.
 An issuing company shall have a consistent track
record of good performance (financial or otherwise)
for a minimum period of three years.
 On the completion of finalization of issue structure the
issuing company shall obtain the final approval for
proceeding ahead with the issue from the Department
of Economic Affairs.
 The Foreign Currency Convertible Bonds shall be
denominated in any freely convertible foreign
currency and the ordinary shall be denominated in
Indian rupees .

Process of Issuing FCCB
 When an issuing company issues ordinary shares or
bonds under this Scheme, to a Domestic Custodian
Bank who will, in terms of agreement, instruct the
Overseas Depositary Bank to issue bonds held by the
Domestic Custodian Bank
 The provisions of any law relating to issue of capital
by an Indian company shall apply in relation to the
issue of Foreign Currency Convertible Bonds.
 Provisions relating to end-use of FCCB proceeds,
repatriation of proceeds, etc., would be altered by the
government from time to time depending on inflow
and outflow in to forex reserves

Advantages of FCCBs
 It is a low cost debt as the interest rates given to FCC
Bonds are normally 30-50 per cent lower than the
market rate because of its equity component.
 Conversion of bonds into stocks takes place at a
premium price to market price.
 Conversion price is fixed when the bond is issued So,
lower dilution of the company stocks
 Simple regulatory process

Disadvantages of FCCBs
 FCC Bonds are ideal for the bull market scenario as
the conversion occurs at a premium price lowering the
dilution.
 But if the stock price plummet like what we are
witnessing right now due to the economic
downturn, then investors will not go for conversion, and
they go for redemption at maturity value.
 So companies have to re-finance to fulfill the redemption
promise
 Earnings will get hit because of the redemptions.
 If the investors do not go for conversion, then companies
will be forced to lower the conversion price (previously
fixed) to entice the investors to go for conversion which
will lead to higher dilution.66 Mrs. Charu Rastogi, Asst. Professor

Disadvantages of FCCBs
 If the stock price goes below the conversion price, then the
issuer loses an opportunity to dilute at a higher price.
 Exchange risk is more in FCCBs as interest on bond would
be payable in foreign currency.
 If the exchange rate goes-up, then the issuer has to pay more
to the investors
 Thus companies with low debt equity ratios, large forex
earnings potential only opt for FCCBs.
 FCCB means creation of more debt and a forex outflow in
terms of interest which is in foreign exchange
 In case of convertible bond the interest rate is low (around
3 to 4%) but there is exchange risk on interest as well as
principal if the bond is not converted in to equity.

FCCBs in India
 Following the sustained liberalisation programme undertaken by
the Indian Government to integrate with the global economy, the
foreign currency convertible bond (FCCB) market took a
quantum leap during the bull run of 2005– 2008. Reports state
that 201 Indian companies raised approximately US$16bn
through FCCBs during that period
 Companies issued FCCBs to reduce their borrowing costs. They
issued the bonds at very low coupon rates; some were even zero
coupon. However, they fixed the conversion prices between 25
per cent and 150 per cent higher than the prevailing market
prices in expectation of an increase in share prices. This theory
fell flat with the subsequent crash in global equity markets. It is
estimated that two thirds of the FCCBs due to mature before
March 2013 will not be converted into equity shares.

FCCBs in India
 Most of the FCCBs that will mature in 2012 were issued in the
years 2007–2008, when the foreign exchange rate was
approximately 42 Indian rupees (INR) to a US dollar. The INR
has since lost more than 30 per cent against the US dollar. This
has added approximately US$2bn to the value of FCCB
maturities in 2012.
 In cases where the current price is trading at a significant
discount to the conversion price, it appears that the companies
will need to adopt other alternatives to pay back their investors.
Although a number of companies have managed to convert their
FCCBs to equity, low investor appetite and the expensive debt
market are making it difficult for further conversions to take
place. In the present market, companies have the following
options

FCCBs in News for wrong
reasons
 Wind turbine manufacturer Suzlon Energy has
defaulted on $221 million worth of foreign
currency convertible bonds (FCCBs) maturing on
October 11, 2012, after it failed to get an
extension from bondholders.
 This is the biggest FCCB default by an Indian
corporate, topping Sterling Biotech‟s $184-million
delinquency in May and takes the quantum of
defaults on convertibles to $664 million this year,
according to data compiled by Bloomberg.
 More on FCCBs
 And more70 Mrs. Charu Rastogi, Asst. Professor

American Depository Receipt

American Depository Receipt
 An American Depositary Receipt (or ADR) represents ownership
in the shares of a non- U. S. company and trades in U.S.
financial markets . The stock of many non-U. S. companies trade
on U.S. stock exchanges through the use of ADRs.
 ADRs enable U. S. investors to buy shares in foreign companies
without the hazards or inconvenience of cross-border and cross
– currency transactions. ADRs carry prices in U.S. dollars, pay
dividends in U. S. dollars, and can be traded like the shares of U.
S. based companies.
 Each ADR is issued by a U. S. Depositary bank and can
represent a fraction of a share , a single share, or multiple
shares of the foreign stock .
 An owner of an ADR has the right to obtain the foreign stock it
represents, but US investors usually find it more convenient
simple to own the ADR.
 For meeting large requirements of funds, raising funds through
ADR is the solution72 Mrs. Charu Rastogi, Asst. Professor

Benefits of ADRs
Benefits to the Issuing Company :
 An ADR programme can stimulate investor
interest, enhance a company‟s visibility, broaden its
shareholder base, and increase liquidity.
 By enabling a company to tap US equity markets, the ADR
offers a new avenue for raising capital ,often at highly
competitive costs.
 For companies with a desire to build a stronger presence
in the United States, an ADR programme can help finance
US initiatives or facilitate US acquisitions.
 ADRs provide an easy way for us employees of non-US
companies to invest in their companies ‟ employee stock
purchase plans .
 May increase local prices as a result of global demand /
trading through a more broadened and a more diversified

Benefits of ADRs
Benefits to the Investors:
 Increasingly investors aim to diversify their portfolios internationally.
 Obstacles, however, such as undependable settlements, costly
currency conversions, unreliable custodial services, poor
information flow, unfamiliar market practices , confusing tax
convention and internal investment policy may discourage
institutions and private investors from venturing outside their local
market.
 As negotiable securities, ADRs are quoted in US dollars and pay
dividend or interest in US dollars .
 They overcome the obstacles that mutual funds, pension funds and
other institutions may have in purchasing and holding securities
outside the local market .
 Depository Receipts are easy to Buy and Sell:
 Investors purchase and sell depository receipts through their US brokers
in exactly the same way as they purchase or sell securities of US
companies.
 Many regional NASD brokers/dealers, and virtually all New York
brokers/dealers, make market in and know how to create depository
receipts.
 Depository Receipts are Liquid : Depository receipts are as liquid as their

Global Depository Receipt

 It is global finance vehicle that allows an issuer to raise
capital simultaneously in two or more markets through a
global offering
 They are marketed internationally, mainly to financial
institutions.
 Global Depository Receipt (GDR) –certificate issued by
international bank, which can be subject of worldwide
circulation on capital markets.
 For example, a European investor wanting an exposure in
Indian securities could do so via two routes:
 Enter the Indian stock market and buy the company‟s
stock on one of the Indian markets.
 But this would also expose the investor to exchange risks
and statutory rules and regulations governing purchase
and sale of securities in the Indian markets.
 Through GDRs which would give the investor ownership
of the Indian company‟s stock without being subject to
Indian stock market regulations to a great extent.

 GDRs have become synonymous with selling equity in the
Euromarkets.
 This is so because fresh shares are issued by the
company which is raising money from the markets, and
transferred to a depository which , in turn, issues a receipt
which is quoted and traded at any stock exchange where
it is listed.
 Thus, a GDR is a negotiable instrument denominated in
dollars or some other freely convertible currency.
 It is used as a funding vehicle for raising capital
 The GDR structure allows for simultaneous issuance of
securities in multiple markets .
 This facilitates greater liquidity trough cross border trading
GDRs can be issued in either public or private markets in
the US other countries.

 A GDR gives its holder the right to get equity shares
of the issuer company against the GDR as per the
term of the offer.
 Till such exchange or conversion takes place, the
GDR does not carry any voting rights. The shares
represented by a GDR are identical to other equity
shares in all respects.
 Once a GDR is issued, it can be traded freely among
international investors. GDRs are freely tradable in
the overseas market like any other dollar
denominated security either on a foreign stock
exchange or in the OTC market.

Benefits
 Access to capital markets outside the home market.
 Enhancement of company visibility.
 Increases potential liquidity by enlarging the market for the
company‟s shares.
 It helps the issuing company to extend its research base to
foreign countries
Benefits to Investors:
 They facilitate diversification into foreign securities.
 Eliminate custody charges.
 Can be easily compared to securities of similar companies.
 Permit prompt dividend payments and corporate action
notifications.
 GDRs offer most of the same corporate rights, especially
voting rights, to the holders of GDRs.

FDI

Foreign Direct Investment
 The United Nation‟s World Investment Report
(UNCTAD,1999) defines FDI as “an investment
involving a long – term relationship and reflecting a
lasting interest and control of a resident entity in one
economy (foreign direct investor or parent‟ enterprise)
in an enterprise resident in an economy other than
that of the foreign direct investor (FDI ) enterprise,
affiliate enterprise or foreign affiliate).”
 The term “long-term” used in the last definition in
order to distinguish FDI from portfolio investment; FDI
does not have the portfolio investment characteristic
of being short – term in nature, involving a high
turnover of securities.

Types of FDI
 Horizontal
 It refers to FDI in the same industry in which the organization
operates in the home nation.
 For example, Cemex, Mexico‟s largest cement manufacturer,
embarked upon its international expansion strategy by acquiring
established cement makers in Venezuela, Colombia, Indonesia
and Egypt. In 2000, it acquired Houston based Southland, a large
cement company of the United States of America, by paying 2.5
billion dollars .
 Vertical
 It refers to the FDI by an organization in order to sell the outputs of
domestic firms or it refers to the investment which provides inputs to the
domestic organization
 For example, in 2001, Russia‟s largest oil company , LU Koil, acquired
the Getty Petroleum of U.S.A., which provided it a retail network of about
1300 gasoline staions.
 The firms such as Shell, British Petroleum ,RTZ, Acoa and so on ,
have gone for FDI in oil extractive industry ,in order to get a
regular and stable supply of the inputs

Types of FDI
 Green field Investments
 It is the direct investment in new facilities or the
expansion of existing facilities.
 It is the principal mode of investing in developing
counters.
 Mergers & Acquisitions
 It occurs when a transfer of existing assets from local firms
takes place

Benefits of FDI
 To Host Country
 Availability of Scarce Factors of Production: FDI helps attain a
proper balance among different factors of production through the
supply of scarce factors and fosters the pace of economic
development.
 FDI brings in capital and supplements the domestic capital. This
is a significant contribution where the domestic savings rate is too
low to match the warranted rate of investment.
 It brings in scarce foreign exchange that activates the domestic
savings that would not have been put into investment in absence
of the availability of foreign exchange .
 Improvement in the Balance of Payments: FDI helps improve the
balance of payments of the host country.
 The inflow of investment is credited to the capital account.
 At the same time, the current account improves because FDI
helps either import substitution or export promotion.
 The host country is able to produce those items that were being
imported earlier.

Benefits of FDI
To host country (contd.)
 Building of Economic and Social Infrastructure:
 When the foreign investors invest in sectors such as the basic economic
infrastructure, social infrastructure, financial markets and the marketing system, the
host country is able to develop a support system that is necessary for rapid
industrialization.
 Even if there is no investment in these sectors, the very presence of foreign
investors in the host country creates a multiplier effect and the support system
develops automatically.
 Fostering of Economic Linkages :
 Foreign firms have forward and backward linkages. They make demand for various
inputs that in turn helps develop the input-supplying industries which is known as
crowding – in effect.
 They employ labor force and so help raises the income of the employed people
that in turn raises the demand and industrial production in the country.
 Strengthening of Government Budget :
 The foreign firms are a source of tax income for the government .
 They pay not only income tax , but tariff on their import as well .
 At the same time , help reduce the governmental expenditure requirements
through supplementing the government‟s investment activities . All this eases the
burden on the national budget.

Benefits of FDI
 To Home Country
 Improvement in Balance of payment : inflow of foreign
currencies in the form of dividend , interests etc.
 Industrial Activity:
 FDI increases export of machinery , equipment, technology etc from
the home country to host country .
 This is enhances the industrial activity of the home country.
Employment Generation The increased industrial activity in the home
country enhances employment opportunities.
 Learning Skills : The firm and other country firms can learn
skills from its exposure to the host country and transfer those
skill to the industry in the home country .
 Improved Political relations: FDI is complement to foreign aid;
it helps develop closer political ties between the home country
and the host country which is beneficial for both the countries.

Costs of FDI
 To host country
 Adverse Effects on Competition: The new foreign subsidiaries
may grow to have more economic power and more
attractively priced products than the host country companies .
 Adverse Effects on Balance-of –Payments : If the foreign
subsidiary imports large quantities – this contributes to the
home country having a balance-of-payments deficit.
 Adverse Effects on Natural Resources: Raw materials are
exploited keeping in view the interest of the home country that
is sometimes detrimental to the interest of the host country.
 No Employment Opportunities: As far as employment of locals
is concerned, the MNCs normally show reluctance to train the
local people .
 Technology being normally capital-intensive does not assure
larger employment .

Costs of FDI
 To home country
 Undesired outflow of factor of production
 The cost accruing to the home country is only little,
 However, it cannot be denied that making investment abroad
takes away capital ,skilled manpower & managerial
professional from the country.
 Sometimes the outflow of these factors of production is so
large that it hampers the home country‟s interest
 Possibility of conflict with the host –country government
 The MNCs operates in different countries in order to maximize their
overall profit .
 To this end, they adopt various techniques that may not be in the
interest of the host country.
 This leads to a tussle between the host government & the home
government which may have a deleterious effect on bilateral relations

Loan Syndication

Loan Syndication
 When the size of the lending is huge running into a few
hundred millions or billions, a few banks join together and
provided the loan.
 It owes its evolution to U.S. laws, which fixed certain limits
on lending exposure of a single bank on a single borrower.
 A syndicate credit is the agreement between two or more
lending institutions to provide a borrower a credit facility
utilizing common loan documentation.
 A syndicated loan is defined as:
 “International syndicated credit are managed and underwritten
by one or more financial institutional normally from a location
other than domicile of the borrower to include lenders from
differing banking geographic which provide the borrower
access to more than its own currency of domicile”.

Loan Syndication
 Syndicated Loan involves many banks coming
together to meet debt requirement of a client.
 It typically involves one or more banks underwriting
the loan and acting as Mandated Lead Arrangers
(MLAs).
 Minimum amount of syndicated loan raised is
normally 50 millions U.S. dollar and the maximum is
normally 5 billion U.S. dollar and are given for a
period ranging from 365 days to 20 years.

Players in Syndicated Loan
 Managing Bank/Mandated Lead Manager:
 Managing bank is appointed by the borrower to arrange the credit. The
managing bank helps the borrower to draw up the loan application, it
negotiates the terms and conditions with other banks and arranges the
syndicate.
 The managing bank‟s role come to an end with the signing of loan
agreement by the borrower and the participating banks.
 Lead Bank :
 Lead bank is the bank which provides the major chunk of the loan.
 Agent Bank :
 Agent bank is the bank appointed by the lenders to look after their
interest once the loan agreement is signed. They take over from the
managing bank.
 Participating Bank:
 The participating in a syndicated loan fall into the following segments.
 The wholesale large commercial banks, who arrange the credits, take
lion‟s shares.
 The retail sector small banks take whatever share is given to them and
take a participation in the loan syndication.

Advantages
 Advantages
 Allows raising of large amount even running into billions of
dollars.
 Better visibility for both banks as well the company as these
transactions are typically accompanied by news coverage as
well as road shows in which many banks not present in the
country are invited.
 Common Documentation as well as facility agents ensure that
transactions are smooth.
 Banks are able to distribute credit risk on a client.
 Credit risk is spread / distributed among many banks . In view
of exposure limit and higher capital, adequacy ratio not
considered prudent for one bank to undertake such lending.
 Syndicated loan facility strengthens the relationship between
the borrowers and a bank , thereby providing opportunity to
enter into new market segments of high net worth borrowers
 There is a secondary market for the syndicated loan –any
bank can at a later stage sell its share to other takers

Disadvantages
 Disadvantages
 Generally take longer than bilateral loans
 Documentation is more complex.
 Generally costlier than bilateral loans.
 Generally borrowers with credit profile in upper
bracket are able to raise through this route
 If borrowing countries are unable to meet their
obligations on time, the banks will be forced to roll
over their loans indefinitely.

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