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Chapter no: 1

Introduction to Foreign payment

1.1

Introduction

The importance of international trade in the economy of a country is too well


known to require emphasis. A number of advantages flow from international
trade. Many developed nations of the world owe their present status to
international trade; many developing countries place their hopes of development
on it. A common man, who is not keenly interested in these use a large number
of these items are either imported or some components of them are imported.
Even if an item is indigenously produced, it may be found that it is made on an
imported machine.

1.2

Foreign Trade and Foreign Exchange

International trade refers to trade between the residents of two different


countries. Each country functions as a sovereign state with its own set of
regulations and currency. The difference in the nationality of the exporter and
the importer presents certain peculiar problems in the conduct of international

trade and settlement of the transactions arising there from. Important among
such problems are:
Different countries have different monetary units;
. Restrictions imposed by countries on import and export of goods;
Restrictions imposed by nations on payments from and into their
countries;
Differences in legal practices in different countries.
The existence of national monetary units poses a problem in the settlement of
international transactions. The exporter would like to get the payment in the
currency of his own country.
For instance, if amerexport of New York export machinery to in imports,
Mumbai, the former would like to get the payment in US dollars. Payment in
Indian rupees will not serve their purpose because Indian rupee cannot be used
as currency in the USA. On the other hand, the importers in India have their
savings and borrowings in Indian in rupees. Thus the exporter requires payment
in the currency of the exporters country whereas the importer can pay only in
the currency of the importers country. A need, therefore, arises for conversion
of the currency of the importers country into that of the exporters country.
Foreign exchange is the mechanism by which the currency of one country gets
converted into the currency of another country.

The conversion of currencies is done by banks who deal in foreign exchange.


These banks maintain stocks of foreign currencies in the form of balance with
banks abroad.
For instance, Indian bank may maintain an account with bank of America. New
York, in which dollar balances are held,. In the earlier example, if in imports
pay the equivalent rupees to Indian bank, it would arrange to pay amerexport at
New York in dollars from the dollar balances held by it with bank of America.

1.3 Foreign Exchange Regulation Act


The Foreign Exchange Regulation Act (FERA) was legislation
passed by the Indian Parliament in 1973 by the government of Indira
Gandhi and came into force with effect from January 1, 1974. FERA
imposed stringent regulations on certain kinds of payments, the dealings in
foreign exchange and securities and the transactions which had an indirect
impact on the foreign exchange and the import and export of currency. The
bill was formulated with the aim of regulating payments and foreign
exchange.
Coca-Cola was India's leading soft drink until 1977 when it left
India after a new government ordered the company to turn over its secret
formula for Coca-Cola and dilute its stake in its Indian unit as required by
the Foreign Exchange Regulation Act (FERA). In 1993, the company (along

with PepsiCo) returned after the introduction of India's Liberalization


policy.
FERA was repealed in 1998 by the government of Atal Bihari
Vajpayee and replaced by the Foreign Exchange Management Act, which
liberalized foreign exchange controls and restrictions on foreign investment.
1.4

FERA :
Regulated in India by the Foreign Exchange Regulation Act (FERA),

1973. Consisted of 81 sections. FERA Emphasized strict exchange control.


Control everything that was specified, relating to foreign exchange. Law
violators were treated as criminal offenders. Aimed at minimizing dealings
in foreign exchange and foreign securities.
FERA was introduced at a time when foreign exchange (Forex)
reserves of the country were low, Forex being a scarce commodity. FERA
therefore proceeded on the presumption that all foreign exchange earned by
Indian residents rightfully belonged to the Government of India and had to
be collected and surrendered to the Reserve bank of India (RBI). FERA
primarily prohibited all transactions, except ones permitted by RBI.

OBJECTIVES :
To regulate certain payments.
To regulate dealings in foreign exchange and securities.
To regulate transactions, indirectly affecting foreign exchange.
To regulate the import and export of currency.
To conserve precious foreign exchange.
The proper utilization of foreign exchange so as to promote the
economic development of the country.

Chapter No: 2
INTERNATIONAL PAYMENT
Payment made between countries, whether in settlement of a trade debt, as a
unilateral transfer of funds, for capital investment, or for some other
purpose. The reasons for such payments and the methods of making them
and accounting for them are matters of concern to economists and national
governments. International debts are settled either from accumulated
balances of foreign currency or claims on foreign currency, or by loans from
creditor to debtor, or by drawing on the International Monetary Fund, or by
movements of gold. How a country balances its international accounts is
one of the most important decisions for its balance of payments.
Methods of Payment in International Trade
This guide explains the different methods of getting paid and the different levels
of risks involved. You should note that none of the methods outlined below will
completely eliminate the payment risks associated with international trade, so
you should consider your preferred payment option with care and hedge the
risks along with appropriate credit insurance and credit checks on your
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customers. You should read it if you trade internationally and want to know
what your options are in making and receiving international payments. You may
wish to pass on the information in this Briefing to your colleagues in the Sales
& Marketing team and your Finance Director so that they are aware of these
issues.
Introduction

Getting paid for providing goods or services is critical for any business.
However, getting paid for an international transaction (also commonly known
as "export receivables") can be a very different experience from securing
payment on business with other UK entities, due to the number of extra factors
that can influence the process. The main factor in considering how an exporter
expects to be paid for a transaction is the potential risk that they and their
customer are willing to face between them - don't forget, there are always two
sides to any situation. There are different types of risk that you will face as an
exporter, this briefing will consider the payment risk.

Payment Risk Ladder

It is often a good idea, during, or even before contract negotiations, to consider


where, on the diagram below, you and your customer will be comfortable in
placing yourselves.

Exporter

Impoter

Least Secure

Most Secure

Open Account
Bills Of Collection
Letter Of Credit
Advance Payment
Most Secure

Least Secured

Common Payment Methods


Once acceptable risks have been determined then the most appropriate
payment method can be selected. While this document is a useful starting
point, the advice of a qualified financier or banker should be sought at least
for the first transactions.
Cash in advance
Letter of credit
Documentary collection
Open account or credit
Countertrade or Barter
Bills for Collection
Here is a list, beginning with those that present the least risk for the seller,
of the most common payment methods. They are further described below
Cash in Advance
Cash in advance clearly is risk-free except for consequences
associated with the potential nondelivery of the goods by the seller. Cash
in advance is usually a wire transfer or a check. Although an international
wire transfer is more costly (from U.S. $15 to more than U.S. $100), it is
often preferred because it is speedy and does not bear the danger of the
check not being honored. The check can be at a disadvantage if the
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exchange rate has changed significantly by the time it arrives, clears and
is credited. On the other hand, the check can make it easier to shop for a
better exchange rate between different financial institutions.
For wire transfers the seller must provide clear routing instructions in
writing to the buyer or the buyer's agent. These include:
The full name, address, telephone, and telex of the seller's bank
The bank's SWIFT and/or ABA numbers2
The seller's full name, address, telephone, type of bank account , and
account number.
No further information or security codes should be offered.
Letter of Credit
Basic Understanding
The letter of credit (LC) allows the buyer and Seller to contract a
trusted intermediary (a bank) that will guarantee full payment to the seller
provided that he has shipped the goods and complied with the terms of the
agreed-upon Letter. This instrument, although inherently simple, can have
many variations. The LC serves to evenly distribute risk between buyer and
seller since the seller is assured of payment when the conditions of the LC
are met and the buyer is reasonably assured of receiving the goods ordered3.

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This is a common form of payment, especially when the contracting parties


or unfamiliar with each other. Although this instrument provides excellent
assurances to both parties, it can be confusing and restrictive. It can also be
somewhat expensive, ranging from several hundred U.S. dollars up to 5
percent of the total value.
LCs are typically irrevocable, which means that once the LC is
established it cannot be changed without the consent of both parties.
Therefore the seller, especially when inexperienced, ought to present the
agreement for an LC to an experienced bank, a trusted broker, and its freight
forwarder so that they can help to determine if the LC is legitimate and if all
the terms can be reasonably met. A trusted bank, other than the issuing or
buyers bank can guarantee the authenticity of the document for a fee.
Disadvantages
The LC has certain disadvantages.
If even the smallest discrepancies exist in the timing, documents or
other requirements of the LC the buyer can reject the shipment.

A rejected shipment means that the seller must quickly find a new
buyer, usually at a lower price, or pay for the shipment to be
returned or disposed.

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Besides being one of the most costly forms of payment guarantee


LCs also take time to draw up and usually tie up the buyer's
working capital or credit line from the date it is accepted until final
payment, rejection for noncompliance, expiration or cancellation
(requiring the approval of both parties).
The terms of an LC are very specific and binding. Many traders,
even experienced ones, encounter significant difficulties because of
their failure to understand or comply with the terms.
Some statistics show that approximately 50 percent of submissions
for LC payment are rejected for failure to comply with terms!
For example: if the terms require the delivery of four specific
documents and one of them is incomplete or merely delivered late
then payment will be withheld regardless of whether every other
condition was fulfilled and the shipment received in perfect order.
The banks whose job it is to ensure a safe payment transaction will
insist that the terms be a fulfilled exactly as written. The buyer can
sometimes approve the release of payment if a condition is not
fulfilled but changing terms after the fact is costly, time consuming
and sometimes impossible.

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Four Parties Are Involved In Any Transaction Using An LC:


Buyer or Applicant: The buyer applies to his bank for the
issuance of an LC. If the applicant does not have a credit
arrangement with this issuing bank then he must pay in cash or
other negotiable security.
Issuing bank: The issuing or applicant's bank, issues the LC in
favor of the beneficiary and routes the document to the
beneficiary's bank. The applicant's bank later also verifies that all
of the terms, conditions, and documents comply with the LC, and
pays the seller through his bank.

Beneficiary's bank: The sellers or beneficiary's bank verifies that


the LC is authentic and notifies the beneficiary. It, or another
trusted bank, can act as an advising bank. The advising bank is
used as a trusted bridge between the applicant's bank and the
beneficiarys bank when these do not have an active relationship
and to verify the authenticity of a document. It also forwards the
beneficiary's proof of performance and documentation back to the
issuing bank. However, the advising bank has no liability for
payment of the LC. The beneficiary, or his bank, can ask an
advising bank to confirm the LC. This means that the confirming
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bank also promises to ensure that the beneficiary is paid when he is


in compliance with the terms and conditions of the LC. The
confirming bank charges a fee for this service. This is most useful
when the issuing bank and its credibility is not familiar to either the
beneficiary or his bank, or if the issuing bank (even a wellestablished one) is in a high-risk country.
Beneficiary or Seller: The beneficiary must ensure that the order
is prepared according to specifications and shipped on time. He
must also gather and present the full set of accurate documents, as
required by the LC, to the bank.

Drafts
A draft (sometimes called a bill of exchange) is a written order by one
party directing a second party to pay a third party. Drafts are negotiable
instruments that facilitate international payments through respected
intermediaries such as banks but do not involve the intermediaries in
guaranteeing performance. Such drafts offer more flexibility than LCs
and are transferable from one party to another.

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There are two basic types of drafts: sight drafts and time drafts.
Sight Drafts: Sight drafts are the most familiar kind of draft, as a sight
draft would be a check. The characteristics of a sight draft include those
of all drafts, with the distinguishing trait that sight drafts are always
payable when presented, in a manner somewhat akin to bearer
instruments. This means that upon the presentation of such sight draft, the
drawee would be required to immediately pay the presenter without any
substantial delay. Sight drafts are most often used for those interpersonal
payments or in shipping transactions, for example, when the seller does
not want the buyer to gain control of the shipment until payment has been
made. In such an instance, a sight draft would ensure that the seller would
have an immediately payable draft before transferring title of the goods to
the buyer.
Time Draft: A time draft is differentiated from a sight draft by the fact
that it has a set payment date some time in the future, as opposed to
immediately upon presentation of the draft. A time draft does not have to
be set for a specific date. It can instead be set so that it is only payable
upon the fulfillment of certain conditions. The point of a time draft is to
delay any form of payment until certain actions will likely have occurred.
Time drafts are the only type of draft used with acceptances. Acceptances
are used, as in the above example, when the drawee of a draft negotiable

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instrument "accepts" the draft, essentially promising the payee that it will
provide payment to the payee upon satisfaction of the terms in the draft.
A sight draft would never require such an acceptance, however, as a sight
draft would always require the drawee to pay the payee presenting the
sight draft.
Hybrid Methods
In practice, international payment methods tend to be quite flexible and
varied. Frequently, trading partners will use a combination of payment
methods. For example: the seller may require that 50% payment be made
in advance using a wire transfer and that the remaining 50% be made by
documentary collection and a sight draft.
Open Account
Open account means that payment is left open to an agreed-upon future
date. It is one of the most common methods of payment in international
trade and many large companies will only buy on open account. Payment
is usually made by wire transfer or check. This can be a very risky
method for the seller unless he has a long and favorable relationship with
the buyer or the buyer has excellent credit. Still, there are no guarantees
and collecting delinquent payments is difficult and costly in foreign
countries especially considering that this method utilizes few official and
legally binding documents. Contracts, invoices, and shipping documents

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will only be useful in securing payment from a recalcitrant buyer when


his countrys legal system recognizes them and allows for reasonable (in
terms of time and expense) settlement of such disputes.
Bills for Collection
More secure for an exporter than Open Account trading, as the exporter's
documentation is sent from a UK bank to the buyer's bank. This
invariably occurs after shipment and contains specific instructions that
must be obeyed. Should the buyer fail to comply, the exporter does, in
certain circumstances, retain title to the goods, which may be recoverable.
The buyer's bank will act on instructions provided by the exporter, via
their own bank, and often provides a useful communication route through
which disputes are resolved. The Bills for Collection process is governed
by a set of rules, published by the International Chamber of Commerce
(ICC) called "Uniform Rules for Collections" document number 522
(URC522). Over 90% of the world's banks adhere to this document - pick
up a copy from the ICC (See contact details below) or your bank and
familiarise yourself with the contents.
There are two types of Bill for Collection, which are usually determined
by the payment terms agreed within a commercial contract. Different
benefits are afforded to exporters by each and they are covered separately
below.
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International Payment Instruments Comparison Chart

Payment

Features

Advantages

Disadvantages

Method
Cost is usually more
than other means of

Wire
Transfer

Fully electronic means

payment Funds can be

of payment Uses

hard to recover if

correspondent bank

Fastest way for

payment goes astray

accounts and Fed Wire

Beneficiary to

Intermediary banks

U.S. Dollars and

receive good

deduct charges from the

foreign currencies

funds

proceeds Details needed

Same convenience and

Easy to trace

to apply funds

security as domestic

movement of

received for credit

wires Pin numbers for

funds from bank

management

each authorized

to bank

purposes are often

individual Repetitive

lacking/insufficient

codes for frequent

Impossible to stop

transfers to same

payment

Beneficiaries

after execution

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Paper instrument that

Convenient when

Mail or courier delivery

must be sent to

Beneficiary's

can be

Beneficiary and is

bank details are

slow

payable in

not known

Good funds must still

Foreign

Beneficiary's

Useful when

be

Checks

country

information/

collected from the

Uses account

documentation

drawee bank

relationships with

must

If payable in foreign

foreign

accompany

currency,

correspondent banks

payment

value may change

Available in U.S.

(subscriptions,

during the

Dollars and all major

registrations,

collection period

foreign currencies

reservations, etc.)

Stale dating rules differ

Relatively easy to

in

stop payment

various countries

if necessary

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Rights and risks


of Buyer and
Seller are
Bank's credit replaces

balanced

More costly than other

Buyer's credit

Seller is assured

payment

Payment made against

of payment

alternatives

Commercial

compliant

when conditions

Issuance and

Letters of

documents

are met

amendments

Credit

Foreign bank risk can

Buyer is

can take time

be eliminated via

reasonably

Strict documentary

confirmation of a bank

assured of

compliance

in Beneficiary's

receiving the

by Seller is required

country

goods ordered

Reduces applicant's

Acceptance credits

Confirmation

credit

offer built-in financing

eliminates

facilities

opportunity

country risk and


commercial
risk

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May be cheaper
than
Powerful instrument

Commercial

with simple language

Letter of Credit

Weak language can give

Increasingly popular in

More secure than

Beneficiary unintended

Standby

U.S. and abroad

open account

advantages

Letters of

Foreign bank risk can

or Documentary

More costly than

Credit

be eliminated via

Collection

Documentary

confirmation of a bank

Discrepancies less

Collections

in Beneficiary's

likely than

Reduces Buyer's credit

country

under Commercial

facilities

"Evergreen" clauses

L/C

shift expiry risk from

Confirmation

Beneficiary to issuer

eliminates
country risk and
commercial
risk

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Documentary
Collections

Seller uses banks as

Somewhat more

Country risk and

agents to present

secure than

commercial

shipping documents to

open account

risk exist

Buyer against

Cheaper and less

No guaranty of payment

Buyer's payment or

rigid than

by any

promise to pay

Commercial L/C

bank

With Direct Collection

No strict

No protection against

Letter (DCL), Seller

compliance rules

order

ships and sends

apply

cancellation

shipping documents

No credit facilities

No built-in financing

directly to Buyer's

required

opportunity as with

bank, which collects

Commercial L/C

and
remits funds to Seller's
bank

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