BALANCE OF PAYMENT

Shrinking foreign trade

INDIA’s trade deficit during the first three months of current fiscal year (2009-
10) on a balance of payments (BoP) basis was large due to the steeper decline in
the pace of exports than that of imports The trade deficit on a BoP basis in Q1
(US$ 26.0 billion) was, however, less than that in Q1 of 2008-09 (US$ 31.4
billion). This is revealed in e report of the country’s central banking authority
Reserve Bank of India (RBI) on India's Balance of Payments Developments
during the first quarter (April-June) of 2009-10.

The key features of India’s BoP that emerged in Q1 of fiscal 2009-10 were:(i) The
decline in exports which started since October 2008 continued during the first
quarter of 2009-10. Import payments, on a BoP basis, also continued its declining
trend mainly due to lower oil import bill; (ii) Private transfer receipts remained
buoyant and increased by 9.4 per cent to US$ 13.3 billion during Q1 of 2009-10.
Exports of software services, however, declined during Q1 of 2009-10; (iii)
Despite net invisibles surplus at US$ 20.2 billion, the large trade deficit (US$ 26.0
billion) mainly on account of sharp decline in exports led to a current account
deficit of US$ 5.8 billion in Q1 of 2009-10 (US$ 9.0 billion during Q1 of 2008-09);
(iv) With the revival in capital inflows to India, particularly foreign investments,
the capital account showed a turnaround from a negative balance in last two
quarters of 2008-09 to a positive balance of US$ 6.7 billion during Q1 of 2009-10;
(v) Portfolio investment witnessed a sharp turnaround from net outflows of US$
2.7 billion in Q4 of 2008-09 to net inflows of US$ 8.3 billion during Q1 of 2009-
10; (vi) NRI deposits also witnessed higher inflows reflecting the positive impact
of the revisions in the ceiling interest rate on NRI deposits; (vii) There was a
marginal increase in reserves on BoP basis (i.e., excluding valuation) during Q1 of
2009-10. However, the foreign exchange reserves including valuation increased
by US$ 13.2 billion during Q1 of 2009-10 implying that the increase in reserves
during this period was mainly due to valuation gains as the US dollar has
depreciated against major currencies.

Major Items of India's Balance of Payments

(US$ million)

April-June (2008- April-June (2009-

(2007-08) (PR) (2008-09) (P)
09) (PR) 10) (P)

Exports 166163 175184 49120 38789

Imports 257789 294587 80545 64775

Trade Balance -91626 -119403 -31425 -25986

Invisibles, net 74592 89587 22406 20179

Current Account
-17034 -29817 -9019 -5808
Balance

Capital Account* 109198 9737 11254 5923

Change in Reserves#
(+ indicates
-92164 20080 -2235 -115
increase;- indicates
decrease)
Including errors & omissions; # On BoP basis excluding valuation; P: Preliminary, PR: Partially revised. R: revised

SOURCE: Reserve Bank of India Report

Invisibles

(i) During Q1 of 2009-10, invisibles receipts declined marginally, while invisibles

payments recorded a positive growth (Table 2). In net terms, the invisibles
balance at US$ 20.2 billion was lower than that in the corresponding period of the
previous year (US$ 22.4 billion), though higher than that in Q4 of 2008-09 (US$
19.3 billion).

Invisibles Receipts

(i) Invisibles receipts registered a marginal decline of 0.7 per cent in Q1 of 2009-
10 (as against a higher growth of 30.3 per cent in Q1 of 2008-09) on account of a
decline in almost all categories of services except insurance and financial services
and a decline of 20.3 per cent in investment income receipts.

(ii) Exports of software services declined by 11.5 per cent during Q1 of 2009-10
as against an increase of 37.6 per cent in Q1 of 2008-09. According to the
NASSCOM, software services exports are projected to grow by 4 to 7 per cent to
US$ 48 to 50 billion during the financial year 2009-10.

(iii) Travel receipts at US$ 2.3 billion during Q1 of 2009-10 declined by 8.7 per
cent as against an increase of 19.9 per cent in Q1 of 2008-09 reflecting a
slowdown in tourist arrivals in the country since November 2008. According to the
data released by the Ministry of Tourism, foreign tourist arrivals declined by 1.8
per cent in Q1 of 2009-10.

Invisibles Payments

(i) Invisibles payments recorded a positive growth of 11.9 per cent in Q1 of 2009-
10 (13.5 per cent in Q1 of 2008-09) mainly due to growth in payments under
services and income account. In the services account, however, payments under
travel, transportation, G.N.I.E. and software services recorded a negative growth
in Q1 of 2009-10.

(ii) Investment income payments (include mainly the interest payments on

commercial borrowings, external assistance and non-resident deposits, and
reinvested earnings of the foreign direct investment (FDI) enterprises operating in
India) increased marginally to US$ 4.4 billion during Q1 of 2009-10 (US$ 4.1
billion in Q1 of 2008-09) mainly due to increased reinvested earnings of FDI
companies in India (Table 8).
Invisibles Balance

(iii) A combined effect of decline in invisibles receipts and increase in invisibles

payments led to marginally lower net invisibles (invisibles receipts minus
invisibles payments) at US$ 20.2 billion in Q1 of 2009-10 than that in the
corresponding period of the previous year (US$ 22.4 billion) (Table 3). At this
level, however, the invisibles surplus financed about 77.7 per cent of trade deficit
during Q1 of 2009-10 (71.3 per cent during Q1 of 2008-09).

Current Account Deficit

i) Despite net invisibles surplus, the large trade deficit mainly on account of sharp
decline in exports led to a current account deficit of US$ 5.8 billion in Q1 of 2009-
10 (US$ 9.0 billion during Q1 of 2008-09).

Capital Account and Reserves

i) The gross capital inflows to India revived during Q1 of 2009-10 as compared to

the last two quarters of 2008-09 manifesting confidence in India’s long-term
growth prospects. The gross inflows were, however, at US$ 78.5 billion as
compared to US$ 90.9 billion in Q1 of 2008-09 mainly led by inflows under FIIs,
FDI and NRI deposits. Gross capital outflows during Q1 of 2009-10 stood lower at
US$ 71.8 billion as against US$ 79.7 billion in Q1 of 2008-09.

(ii) With the revival in capital inflows to India, particularly foreign investments,
the capital account showed a turnaround from a negative balance in last two
quarters of 2008-09 to a positive balance of US$ 6.7 billion during Q1 of 2009-10
(US$ 11.1 billion in Q1 of 2008-09).

(iv) Net FDI inflows (net inward FDI minus net outward FDI) amounted to US$ 6.8
billion in Q1 of 2009-10 (US$ 9.0 billion in Q1 of 2008-09). Net inward FDI stood
at US$ 9.5 billion during Q1 of 2009-10 (US$ 11.9 billion in Q1 of 2008-09). Net
outward FDI stood at US$ 2.6 billion in Q1 of 2009-10 as compared with US$ 2.9
billion in Q1 of 2008-09.

(v) During Q1 of 2009-10, FDI to India was channeled mainly into manufacturing
sector (19.2 per cent), real estate activities (15.6 per cent), financial services
(15.4 per cent), construction (12.2 per cent) and business services (11.7 per
cent). Mauritius continued to be the major source of FDI during Q1 of 2009-10
with a share of 48.9 per cent followed by USA at 12.8 per cent.

(vi) Portfolio investment primarily comprising foreign institutional investors’ (FIIs)

investments and American Depository Receipts (ADRs)/Global Depository Receipts
(GDRs) witnessed a sharp turnaround from net outflows of US$ 2.7 billion in Q4 of
2008-09 to net inflows of US$ 8.3 billion during Q1 of 2009-10. During 2009-10,
the sharp increase in FII inflows could be attributed to the recovery of domestic
stock market in line with international stock markets, better corporate
performance, political stability and comparatively better growth prospects.

(vii) The tightness in liquidity in the overseas markets continued during Q1 of

2009-10. The approvals of external commercial borrowings (ECBs) were very low
in the first two months of 2009-10, however, it recovered during June 2009. In
addition, repayments of ECBs were higher at US$ 2.1 billion during Q1 of 2009-10
(US$ 1.1 billion during Q1 of 2008-09) resulting in net outflows of US$ 0.4 billion
under ECBs (inflows of US$ 1.5 billion in Q1 of 2008-09).

(viii) The gross disbursements of short-term trade credit was US$ 10.1 billion
during Q1 of 2009-10 almost same in Q1 of 2008-09. The repayments of short-
term trade credits, however, were very high at US$ 13.2 billion in Q1 of 2009-10
(US$ 7.8 billion in Q1 of 2008-09). As a result, there were net outflows of US$ 3.1
billion under short-term trade credit during Q1 of 2009-10 (inflows of US$ 2.4
billion in Q1 of 2008-09).

(ix) Banking capital mainly consists of foreign assets and liabilities of commercial
banks. NRI deposits constitute major part of the foreign liabilities. Banking capital
(net), including NRI deposits, were negative at US$ 3.4 billion during Q1 of 2009-
10 as against a positive net inflow of US$ 2.7 billion during Q1 of 2008-09.
Among the components of banking capital, NRI deposits witnessed higher inflows
of US$ 1.8 billion in Q1 of 2009-10 (net inflows of US$ 0.8 billion in Q1 of 2008-
09) reflecting the positive impact of the revisions in the ceiling interest rate on
NRI deposits.

(x) Other capital includes leads and lags in exports, funds held abroad, advances
received pending for issue of shares under FDI and other capital not included
elsewhere (n.i.e.). Other capital recorded net outflows of US$ 1.6 billion in Q1 of
2009-10.

Balance of Payments (BoP)

Merchandise Trade

Exports

(i) The decline in exports which started since October 2008 continued during the
first quarter of 2009-10. On a BoP basis, India’s merchandise exports recorded a
decline of 21.0 per cent in Q1 of 2009-10 as against an increase of 43.0 per cent
in Q1 of 2008-09.

(ii) As per the data released by the Directorate General of Commercial Intelligence
and Statistics (DGCI&S), merchandise exports declined by 26.4 per cent in Q1 of
2009-10 as against a higher growth of 37.4 per cent in Q1 of 2008-09, reflecting
fall in demand worldwide due to the global economic crisis.
 INDIA’s cumulative value of exports for the period April- August, 2009 was US$ 64129 million (Rs.
311715 crore) as against US $ 92959 million (Rs. 391841 crore) registering a negative growth of 31 per
cent in Dollar terms and 20.4 per cent in Rupee terms over the same period last year. Cumulative value
of imports for the period April- August 2009 was US$ 102300 million (Rs. 497108 crore) as against US$
153691 million (Rs. 648041 crore) registering a negative growth of 33.4 per cent in Dollar terms and
23.3 per cent in Rupee terms over the same period last year.

Oil imports during April- August, 2009 were valued at US$ 28275 million which was 47.4 per cent lower
than the oil imports of US $ 53742 million in the corresponding period last year. Non-oil imports during
April- August, 2009 were valued at US$ 74024 million which was 25.9 per cent lower than the level of
such imports valued at US$99949 million in April- August, 2008.

The trade deficit for April- August, 2009 was estimated at US $38171 million which was lower than the
deficit of US $ 60732 million during April-August, 2008.

EXPORTS & IMPORTS (April-August, FY 2009-10)

In $ Million In Rs Crore

Exports including re-exports

2008-09 92959 391841

2009-10 64129 311715

Growth 2009-10/2008-2009
-31.0 -20.4
(percent)

Imports

2008-09 153691 648041

2009-10 102300 497108

Growth 2009-10/2008-2009
-33.4 -23.3
(percent)

Trade Balance

2008-09 -60732 -256200

2009-10 -38171 -185393

Figures for 2008-09 and 2009-10 are provisional

The trade deficit for April- June, 2009 was estimated at $ 15504 million which was lower than the
deficit at $ 28642 million during April- June, 2008.

Source: Federal Ministry of Commerce, Government of India

Imports

(i) Import payments, on a BoP basis, also continued its declining trend. Imports
declined by 19.6 per cent in Q1 of 2009-10 as against a positive growth of 42.9
per cent in Q1 of 2008-09.
(ii) According to the data released by the DGCI&S, the decline in imports is mainly
attributed to the sharp fall in oil import payments due to lower crude oil prices
during Q1 of 2009-10 (US$ 63.9 per barrel in Q1 of 2009-10 as against US$ 119
per barrel in Q1 of 2008-09). POL imports recorded a sharp decline of 56.9 per
cent during Q1 of 2009-10 as against a sharp increase of 74.2 per cent during Q1
of 2008-09. As per the data released by the Ministry of Petroleum & Natural Gas,
Government of India, POL imports showed a decline of 45.1 per cent during Q1 of
2009-10 despite a quantity growth of 10 per cent mainly due to lower crude oil
price.

(iii) According to the DGCI&S data, out of the total decline in imports of US$ 26.7
billion in Q1 of 2009-10 over the corresponding previous quarter, oil imports
declined by US$ 16.8 billion (share of 63.1 per cent in the decline in total imports
during Q1 of 2009-10 as against 59.8 per cent share in total increase in imports
during Q1 of 2008-09), while non-oil imports decreased by US$ 9.8 billion (share
of 36.9 per cent in the decline in total imports during Q1 of 2009-10 as against
40.2 per cent share in total increase in imports during Q1 of 2008-09).

Inflows & Outflows from NRI Deposits and Local Withdrawals

(In $ million)

Inflows Outflows Local Withdrawals

2006-07 (R) 19914 15593 13208

2007-08 (PR) 29401 29222 18919

2008-09 (P) 37,089 32,799 20,617

2008-09 (Q1) (PR) 9063 8249 5157

2009-10 (Q1) (P) 11172 9354 5568

P: Preliminary, PR: Partially revised. R: revised

SOURCE: Reserve Bank of India report India's Balance of Payments Developments during the First
Quarter (April-June 2009) of 2009-10

Variation in Reserves

(i) The increase in foreign exchange reserves on a BoP basis (i.e., excluding
valuation) was US$ 115 million in Q1 of 2009-10 (as against an accretion to
reserves of US$ 2,235 million in Q1 of 2008-09) (Table 12 & Chart 5). However,
the foreign exchange reserves including valuation increased by US$ 13.2 billion
during Q1 of 2009-10 implying that the increase in reserves during this period
was mainly due to valuation gains as the US dollar has depreciated against major
currencies. [A Press Release on the sources of variation in foreign exchange
reserves is separately issued]. (ii) At the end of June 2009, outstanding foreign
exchange reserves stood at US$ 265.1 billion

-----------------

* India's fiscal year is from April to March

 8. Goods
Sent
Shipping co Shipping co.
MUMBAI DUBAI

Goods
B/L
Goods

B/L

18.
17.
7.
6.

1 Contract US $ 100/
Confirmed L/C
Ahmed & co.
Kirloskar Importer
Exporter, Dubai
India
10. Doc. Checked & Payments

Documents
Payments
5.L/
C

2. L/C

Given
Made
App.

15.

16
3. L/C Sent with a request to advise after adding
made

confirmation
SBI
Advising bank & BBME Dubai
Confirming Bank Issuing bank

Nomination
13. Debits A/C

4.
9. Documents
Submitted

11. Documents
Sent
12. Files Claim For
SBI reimbursement Citibank USA
Negotiating Bank 14 Payments Reimbursing Bank
Made

Letters of Credit [edit]

A letter of credit is a bank instrument that can be used to even the risk between a buyer
and a seller since a buyer is guaranteed to receive payment if when he/she has complied
with the exact requirements of this buyer. A letter of credit offers a seller numerous
advantages but only if that seller complies exactly with its terms and conditions of the
transaction. In addition to providing reduced risk for both a seller and a buyer, there are
many variables that can be used with a letter of credit to reduce the political and
commercial risks that may accompany the transaction as well as provide extended terms
to a buyer through the letter of credit instrument.

The terminology that is used when working with letters of credit is very specific and
should be understood.

Involved Parties:
 • Applicant = Buyer/ Importer
• Beneficiary = Seller/Exporter
• Opening Bank = Importer’s Bank >> Issues L/C
• Advising Bank= Exporter’s Bank >> Advises L/C
• Confirming Bank = Advising Bank or 3rd Party Bank >> Confirms L/C
• Paying Bank = Any Bank as Specified in L/C >> Pays the Draft

Activities and Terms:

• Advice – review and approval of L/C

• Amendment – change to L/C
• Confirmed – the commercial, political and economic risk of the transaction
absorbed by the confirming bank
• Discrepancy – mistake in the documentation
• Documentation – documents required within L/C
• Draft – negotiable order to pay
o Sight Draft – payment assured upon shipment and presentation of
documents in compliance with its terms
o Time Draft – bank assurance of payment at the maturity of the banker’s
acceptance with option of obtaining immediate funds by discounting the
BA (30, 60, 90 days at sight or acceptance)
• Irrevocable – cannot be changed without approval from beneficiary or advising
bank
• Issuance – opening of L/C
• Negotiation – review of documents
• Revocable – can be changed without approval of beneficiary or advising bank

Types of L/Cs: [edit]

• Back-to-Back – credit and terms of a transaction rollover to a new transaction

upon completion, which eliminates the need to apply or issue a new L/C for
identical shipments
• Confirmed – credit risk taken by bank and agreement to pay (fee charged)
• Straight – payable only at paying bank
• Negotiation – payable at negotiating bank
• Sight – payable at acceptance of documents
• Standby – used by the beneficiary for payment should the applicant not pay the
exporter directly
• Transferable – part or all of the proceeds from the L/C may be transferred to
another party, used by sales brokers or agents to disguise buyers and sellers
• Usance – time draft based on invoice, bill of lading, or documents, up to 180 days

Time of •As agreed between the buyer and seller and stipulated in the L/C, at
 Payment sight of documents or acceptance of time draft.
Goods Available •Upon release of documentation and payment or acceptance of time
to Buyer draft.
•Delays in availability of foreign exchange and transferring of funds
from buyer’s country if the L/C is not confirmed.
Risks to Seller
•Payment blocked due to political events in buyer’s country if the L/C
is not confirmed.
•Seller creates documents to comply with L/C but does not ship actual
product.
Risks to Buyer
•Seller does not ship.
•Buyer ties up commercial lines of credit to secure L/C.
A seller should consider a number of factors:
•corporate credit policy and ability to absorb risk
•credit standing of the buyer
•political environment in the importing country
•type of merchandise to be shipped and value of the shipment
When •availability of foreign exchange
Appropriate to •buyer and seller are establishing a new relationship
Quote or Use •when buyer and/or seller’s governments require use of banks to control
flow of currencies and products
•products and/or services comply with quality steps during production
and documentation is presented for payment
•used less frequently in international transactions because of the high
bank fees and time-consuming process
•Often a bank will favorably consider a request for an increase in a
credit line to finance production of the goods. This is done with the
Financing knowledge that letters of credit have been opened and advised to an
exporter for an export order. The bank may further require that the
beneficiary assign its interest in the letter of credit to them.

Types of Letters of Credit [edit]

Revocable [edit]

A revocable letter of credit is one which can be amended or cancelled by the applicant or
the issuing bank at any time, without prior notice, discussion or agreement with the
beneficiary. A revocable letter of credit offers no protection to the beneficiary and is
seldom if ever used.that is in the relation with transferable lc.

Irrevocable [edit]
An irrevocable letter of credit can not be amended or revoked without the agreement of
ALL the parties to the letter of credit, so it provides the assurance that providing the
beneficiary complies with the terms, he/she will be paid for the goods or services. Under
UCP 500, a letter of credit is deemed irrevocable unless otherwise stated.

Unconfirmed [edit]

An unconfirmed irrevocable letter of credit provides a commitment by the issuing bank to

pay, accept, or negotiate a letter of credit. An advising bank forwards the letter of credit
to the beneficiary without responsibility or undertaking on its part except that it must use
reasonable care to check the authenticity of the credit which it advised. It does not
provide a commitment from the advising bank to pay, so the beneficiary is reliant upon
the undertaking of the overseas bank. The beneficiary is not protected from the credit risk
of the issuing bank nor the country risk.

Confirmed [edit]

A confirmed irrevocable letter of credit is one to which the advising bank adds its
confirmation, makes its own independent undertaking to effect payment, negotiation or
acceptance, providing documents are presented which comply with the terms of the letter
of credit. The advising bank, which may also be the confirming bank, assumes the
country (political and economic) risk of the applicant’s country as well as the credit risk,
failure and default of the issuing bank and effects payment to the beneficiary without
recourse.

In order for a letter of credit to be confirmed, a bank accepting this risk would have a
correspondent relationship with the issuing bank. If the advising bank does not have such
a relationship, the letter of credit can be confirmed by an independent bank. The negative
aspect here is the cost of adding another bank to the scenario.

A seller should consider requesting a confirmed credit when

• the credit standing of the issuing bank is unknown to the seller or viewed by the
seller as questionable.
• exchange controls in the buyer’s country may prevent local banks from honoring
certain external payments.
• the importing country is suffering economic difficulties: large external debt and/or
high debt service ratios, a persistent negative balance of payments, or a record of
being late or having defaulted on its international payments.

Transferable Credit [edit]

Under a transferable letter of credit a beneficiary (the first beneficiary) can ask the
issuing/advising/confirming bank to transfer the letter of credit in whole or in part to
another party/ies such as supplier/s (second beneficiary/ies). A transferable letter of credit
is usually used when the beneficiary is not the manufacturer/original supplier of some/all
of the goods/services. This process enables the beneficiary to pay the
manufacturer/original supplier by letter of credit. If the bank agrees, this bank, referred to
as the transferring bank, advises the letter of credit to the second beneficiary/ies in the
terms and conditions of the original letter of credit with certain constraints defined in
Article 48 of UCP 500.

In general, unless the letter of credit states that it is transferable, it is considered non-
transferable.

Assignment of Proceeds [edit]

The right to the proceeds of a letter of credit can sometimes be assigned where the
beneficiary of a letter of credit is not the actual supplier of all or part of the letter of credit
and wants the bank to pay the supplier out of funds received from the letter of credit. The
beneficiary may choose this option if he or she

• does not want to request a transferable letter of credit from a buyer in order to
keep the buyer from knowing who is the actual supplier of the goods.
• does not have the necessary credit with the bank to issue a new letter of credit to a
supplier.

An assignment of proceeds takes the form of an irrevocable instruction from the

beneficiary to the bank requesting that it pay the supplier out of the proceeds of the letter
of credit which becomes due when documents are presented in compliance with the terms
of the letter of credit.

Revolving [edit]

Although infrequently used today, revolving letters of credit were a tool created to allow
companies conducting regular business to issue a letter of credit that could “roll-over”
without the company having to reapply, thus enabling business flow to continue without
interruption as long as the terms and conditions, quantities, and other transaction details
did not change. In addition, if a letter of credit were a revolving one, there were few ways
to stop it from rolling over; so, should a conflict arise between the parties while the letter
of credit was in place or should the products change, there was little recourse for either
party. In the business world today, the fact is that, unless required by law or because of
high risk, on-going business is usually conducted without of letters of credit

Standby [edit]

As is the case with the revolving letter of credit, standby letters of credit are infrequently
used today. A standby letter of credit is one which is issued as a back-up or form of
insurance for the seller should the buyer default on the agreed-upon payment terms. A
standby letter of credit is issued in the same way a documentary credit is in that the
collateral needed for issuance is required by the issuing bank and the beneficiary must
comply with every detail as outlined in the letter of credit. The problem with this
instrument is that the applicant has no guarantee, other than the seller’s word, that the
standby will not be drawn against even if payment is made as agreed. This situation is
challenging, especially if the letter of credit is confirmed and the advising bank sees only
documents pertaining to the shipment as outlined in the letter of credit and has no
knowledge of other payments being made.

Bill of lading
From Wikipedia, the free encyclopedia

A bill of lading (sometimes referred to as a BOL,or B/L) is a document issued by

a carrier to a shipper, acknowledging that specified goods have been received on board as
cargo for conveyance to a named place for delivery to the consignee who is usually
identified. A through bill of lading involves the use of at least two different modes of
transport from road, rail, air, and sea. The term derives from the verb "to lade" which
means to load a cargo onto a ship or other form of transportation.

A bill of lading can be used as a traded object. The standard short form bill of lading is
evidence of the contract of carriage of goods and it serves a number of purposes:

• It is evidence that a valid contract of carriage, or a chartering contract, exists, and

it may incorporate the full terms of the contract between the consignor and the
carrier by reference (i.e. the short form simply refers to the main contract as an
existing document, whereas the long form of a bill of lading (connaissement
intégral) issued by the carrier sets out all the terms of the contract of carriage);
• It is a receipt signed by the carrier confirming whether goods matching the
contract description have been received in good condition (a bill will be described
as clean if the goods have been received on board in apparent good condition and
stowed ready for transport); and
• It is also a document of transfer, being freely transferable but not a negotiable
instrument in the legal sense, i.e. it governs all the legal aspects of physical
carriage, and, like a cheque or other negotiable instrument, it may be endorsed
affecting ownership of the goods actually being carried. This matches everyday
experience in that the contract a person might make with a commercial carrier like
FedEx for mostly airway parcels, is separate from any contract for the sale of the
goods to be carried, however it binds the carrier to its terms, irrespectively of who
the actual holder of the B/L, and owner of the goods, may be at a specific
moment.

Contents
[hide]

• 1 Main types of bill

o 1.1 Straight bill of lading
 o 1.2 Order bill of lading
o 1.3 Bearer bill of lading
o 1.4 Surrender bill of lading
• 2 Other terminology
• 3 A sample of the issues
• 4 Examples
• 5 Notes
• 6 See also
• 7 References

• 8 External links

[edit] Main types of bill

[edit] Straight bill of lading

This bill states that the goods are consigned to a specified person and it is not negotiable
free from existing equities, i.e. any endorsee acquires no better rights than those held by
the endorser. So, for example, if the carrier or another holds a lien over the goods as
security for unpaid debts, the endorsee is bound by the lien. Although, if the endorser
wrongfully failed to disclose the charge, the endorsee will have a right to claim damages
for failing to transfer an unencumbered title.

Also known as a non-negotiable bill of lading; and from the banker's point of view this
type of bill of lading is not safe.

[edit] Order bill of lading

This bill uses express words to make the bill negotiable, e.g. it states that delivery is
to be made to the further order of the consignee using words such as "delivery to A Ltd.
or to order or assigns". Consequently, it can be endorsed by A Ltd. or the right to take
delivery can be transferred by physical delivery of the bill accompanied by adequate
evidence of A Ltd.'s intention to transfer.

[edit] Bearer bill of lading

This bill states that delivery shall be made to whosoever holds the bill. Such bill may be
created explicitly or it is an order bill that fails to nominate the consignee whether in its
original form or through an endorsement in blank. A bearer bill can be negotiated by
physical delivery.

[edit] Surrender bill of lading

Under a term import documentary credit the bank releases the documents on receipt
from the negotiating bank but the importer does not pay the bank until the maturity of the
draft under the relative credit. This direct liability is called Surrender Bill of Lading
(SBL), i.e. when we hand over the bill of lading we surrender title to the goods and our
power of sale over the goods.
("Guide to Trade Terms" (PDF). p. 64.
http://ww2.westpac.com.au/documents/pdf/wibnz/guide-to-trade-terms-payables.
Retrieved 2007-12-13.)

[edit] Other terminology

A sea or air waybill is a non-negotiable receipt issued by the carrier. It is most common in
the container trade either where the cargo is likely to arrive before the formal documents
or where the shipper does not insist on separate bills for every item of cargo carried (e.g.
because this is one of a series of loads being delivered to the same consignee). Delivery is
made to the consignee who identifies himself. It is customary in transactions where the
shipper and consignee are the same person in law making the rigid production of
documents unnecessary.

The UK's Carriage of Goods by Sea Act 1992 creates a further class of document known
as a ship's delivery order which contains an undertaking to carry goods by sea but is
neither a bill nor a waybill.

A straight bill of lading by land or sea, or sea/air waybill are not documents of title to the
goods they represent. They do no more than require delivery of the goods to the named
consignee and (subject to the shipper's ability to redirect the goods) to no other. This
differs from an "order" or "bearer" bill of lading which are possessory title documents
and negotiable, i.e. they can be endorsed and so transfer the right to take delivery to the
last endorsee.

[edit] A sample of the issues

In most national and international systems, a bill of lading is not a document of title, and
does no more than identify that a particular individual has a right to possession at the time
when delivery is to be made. Problems arise when goods are found to have been lost or
damaged in transit, or delivery is delayed or refused. Because the consignee is not a party
to the contract of carriage, the doctrine of privity of contract states that a third party has
no right to enforce the agreement. However, whether this is a problem to the consignee
depends on who owns the goods and who holds the risks associated with the carriage.
This will be answered by examining the terms of all the relevant contracts. If the
consignor has reserved title until payment is made, the consignor can sue to recover his or
her loss. But if ownership and/or the risk of loss has transferred to the consignee, the right
to sue may not be clear in contract, although there could be remedies in tort/delict (the
issue of risk will have been most carefully considered to decide who should insure the
goods during transit). Hence, a number of international Conventions and domestic laws
specifically address when a consignee has the right to sue. The legal solution most often
adopted is to apply the principle of subrogation, i.e. to give the consignee the same rights
of action held by the consignor. This enables most of the more obvious cases of injustice
to be avoided.

In the municipal law of the U.S., the issue and enforcement of bills which may be
documents of title, is governed by Article 7 of the Uniform Commercial Code. However,
since bills of lading are most frequently used in transborder, overseas or airborne
shipping, the laws of whatever other countries are involved in the transaction covered by
a particular bill may also be applicable including the Hague Rules, the Hague-Visby
Rules and the Hamburg Rules at international level for shipping, The Warsaw
Convention for the Unification of Certain Rules for International Carriage by Air 1929
and The Montreal Convention for the Unification of Certain Rules for International
Carriage by Air 1999 for air waybills, etc. It is customary for parties to the bill to agree
both which country's courts shall have the jurisdiction to hear any case in a forum
selection clause, and the municipal system of law to be applied in that case choice of law
clause. The law selected is termed the proper law in private international law and it gives
a form of extraterritorial effect to an otherwise sovereign law, e.g. a Chinese consignor
contracts with a Greek carrier for delivery to a consignee based in New York: they agree
that any dispute will be referred to the courts in New York (since that is the most
convenient place — the forum conveniens) but that the New York courts will apply Greek
law as the lex causae to determine the extent of the carrier's liability.

Types of Letter of Credit

1. Revocable Letter of Credit L/c

A revocable letter of credit may be revoked or modified for any reason, at any time by the
issuing bank without notification. It is rarely used in international trade and not
considered satisfactory for the exporters but has an advantage over that of the importers
and the issuing bank.

There is no provision for confirming revocable credits as per terms of UCPDC, Hence
they cannot be confirmed. It should be indicated in LC that the credit is revocable. if
there is no such indication the credit will be deemed as irrevocable.

2. Irrevocable Letter of CreditL/c

In this case it is not possible to revoked or amended a credit without the agreement of the
issuing bank, the confirming bank, and the beneficiary. Form an exporters point of view
it is believed to be more beneficial. An irrevocable letter of credit from the issuing bank
insures the beneficiary that if the required documents are presented and the terms and
conditions are complied with, payment will be made.

3. Confirmed Letter of Credit L/c

Confirmed Letter of Credit is a special type of L/c in which another bank apart from the
issuing bank has added its guarantee. Although, the cost of confirming by two banks
makes it costlier, this type of L/c is more beneficial for the beneficiary as it doubles the
guarantee.

4. Sight Credit and Usance Credit L/c

Sight credit states that the payments would be made by the issuing bank at sight, on
demand or on presentation. In case of usance credit, draft are drawn on the issuing bank
or the correspondent bank at specified usance period. The credit will indicate whether the
usance draft are to be drawn on the issuing bank or in the case of confirmed credit on the
confirming bank.

5. Back to Back Letter of Credit L/c

Back to Back Letter of Credit is also termed as Countervailing Credit. A credit is known
as backtoback credit when a L/c is opened with security of another L/c.

A backtoback credit which can also be referred as credit and countercredit is actually a
method of financing both sides of a transaction in which a middleman buys goods from
one customer and sells them to another.

The parties to a BacktoBack Letter of Credit are:

1. The buyer and his bank as the issuer of the original Letter of Credit.
2. The seller/manufacturer and his bank,
3. The manufacturer's subcontractor and his bank.

The practical use of this Credit is seen when L/c is opened by the ultimate buyer in
favour of a particular beneficiary, who may not be the actual supplier/ manufacturer
offering the main credit with near identical terms in favour as security and will be able to
obtain reimbursement by presenting the documents received under back to back credit
under the main L/c.

The need for such credits arise mainly when :

1. The ultimate buyer not ready for a transferable credit

2. The Beneficiary do not want to disclose the source of supply to the openers.
3. The manufacturer demands on payment against documents for goods but the
beneficiary of credit is short of the funds

6. Transferable Letter of Credit L/c

A transferable documentary credit is a type of credit under which the first beneficiary
which is usually a middleman may request the nominated bank to transfer credit in whole
or in part to the second beneficiary.
The L/c does state clearly mentions the margins of the first beneficiary and unless it is
specified the L/c cannot be treated as transferable. It can only be used when the company
is selling the product of a third party and the proper care has to be taken about the exit
policy for the money transactions that take place.

This type of L/c is used in the companies that act as a middle man during the transaction
but don’t have large limit. In the transferable L/c there is a right to substitute the invoice
and the whole value can be transferred to a second beneficiary.

The first beneficiary or middleman has rights to change the following terms and
conditions of the letter of credit:

1. Reduce the amount of the credit.

2. Reduce unit price if it is stated
3. Make shorter the expiry date of the letter of credit.
4. Make shorter the last date for presentation of documents.
5. Make shorter the period for shipment of goods.
6. Increase the amount of the cover or percentage for which insurance cover must be
effected.
7. Substitute the name of the applicant (the middleman) for that of the first
beneficiary (the buyer).

Standby Letter of Credit L/c

Initially used by the banks in the United States, the standby letter of credit is very much
similar in nature to a bank guarantee. The main objective of issuing such a credit is to
secure bank loans. Standby credits are usually issued by the applicant’s bank in the
applicant’s country and advised to the beneficiary by a bank in the beneficiary’s country.

Unlike a traditional letter of credit where the beneficiary obtains payment against
documents evidencing performance, the standby letter of credit allow a beneficiary to
obtains payment from a bank even when the applicant for the credit has failed to perform
as per bond.

A standby letter of credit is subject to "Uniform Customs and Practice for Documentary
Credit" (UCP), International Chamber of Commerce Publication No 500, 1993 Revision,
or "International Standby Practices" (ISP), International Chamber of Commerce
Publication No 590, 1998.

Import Operations Under L/c

The Import Letter of Credit guarantees an exporter payment for goods or services,
provided the terms of the letter of credit have been met.

A bank issue an import letter of credit on the behalf of an importer or buyer under the
following Circumstances
 • When a importer is importing goods within its own country.
• When a trader is buying good from his own country and sell it to the another
country for the purpose of merchandizing trade.
• When an Indian exporter who is executing a contract outside his own country
requires importing goods from a third country to the country where he is
executing the contract.

The first category of the most common in the day to day banking

Fees And Reimbursements

The different charges/fees payable under import L/c is briefly as follows

1. The issuing bank charges the applicant fees for opening the letter of credit. The fee
charged depends on the credit of the applicant, and primarily comprises of :

(a) Opening Charges This would comprise commitment charges and usance charged to
be charged upfront for the period of the L/c.

The fee charged by the L/c opening bank during the commitment period is referred to as
commitment fees. Commitment period is the period from the opening of the letter of
credit until the last date of negotiation of documents under the L/c or the expiry of the
L/c, whichever is later.

Usance is the credit period agreed between the buyer and the seller under the letter of
credit. This may vary from 7 days usance (sight) to 90/180 days. The fee charged by bank
for the usance period is referred to as usance charges

(b)Retirement Charges

1. This would be payable at the time of retirement of LCs. LC opening bank scrutinizes
the bills under the LCs according to UCPDC guidelines , and levies charges based on
value of goods.

2. The advising bank charges an advising fee to the beneficiary unless stated otherwise
The fees could vary depending on the country of the beneficiary. The advising bank
charges may be eventually borne by the issuing bank or reimbursed from the applicant.

3. The applicant is bounded and liable to indemnify banks against all obligations and
responsibilities imposed by foreign laws and usage.

4. The confirming bank's fee depends on the credit of the issuing bank and would be
borne by the beneficiary or the issuing bank (applicant eventually) depending on the
terms of contract.

5. The reimbursing bank charges are to the account of the issuing bank.
Risk Associated with Opening Imports L/cs

The basic risk associated with an issuing bank while opening an import L/c are :

1. The financial standing of the importer

As the bank is responsible to pay the money on the behalf of the importer, thereby
the bank should make sure that it has the proper funds to pay.
2. The goods
Bankers need to do a detail analysis against the risks associated with perishability
of the goods, possible obsolescence, import regulations packing and storage, etc.
Price risk is the another crucial factor associated with all modes of international
trade.
3. Exporter Risk
There is always the risk of exporting inferior quality goods. Banks need to be
protective by finding out as much possible about the exporter using status report
and other confidential information.
4. Country Risk
These types of risks are mainly associated with the political and economic
scenario of a country. To solve this issue, most banks have specialized unit which
control the level of exposure that that the bank will assumes for each country.
5. Foreign exchange risk
Foreign exchange risk is another most sensitive risk associated with the banks. As
the transaction is done in foreign currency, the traders depend a lot on exchange
rate fluctuations.

Export Operations Under L/c

Export Letter of Credit is issued in for a trader for his native country for the purchase of
goods and services. Such letters of credit may be received for following purpose:

1. For physical export of goods and services from India to a Foreign Country.
2. For execution of projects outside India by Indian exporters by supply of goods
and services from Indian or partly from India and partly from outside India.
3. Towards deemed exports where there is no physical movements of goods from
outside India But the supplies are being made to a project financed in foreign
exchange by multilateral agencies, organization or project being executed in India
with the aid of external agencies.
4. For sale of goods by Indian exporters with total procurement and supply from
outside India. In all the above cases there would be earning of Foreign Exchange
or conservation of Foreign Exchange.

Banks in India associated themselves with the export letters of credit in various capacities
such as advising bank, confirming bank, transferring bank and reimbursing bank.

In every cases the bank will be rendering services not only to the Issuing Bank as its
agent correspondent bank but also to the exporter in advising and financing his export
activity.

1. Advising an Export L/c

The basic responsibility of an advising bank is to advise the credit received from
its overseas branch after checking the apparent genuineness of the credit
recognized by the issuing bank.

It is also necessary for the advising bank to go through the letter of credit, try to
understand the underlying transaction, terms and conditions of the credit and
advice the beneficiary in the matter.

The main features of advising export LCs are:

1. There are no credit risks as the bank receives a onetime commission for the
advising service.
2. There are no capital adequacy needs for the advising function.

2. Advising of Amendments to L/Cs

Amendment of LCs is done for various reasons and it is necessary to fallow all
the necessary the procedures outlined for advising. In the process of advising the
amendments the Issuing bank serializes the amendment number and also ensures
that no previous amendment is missing from the list. Only on receipt of
satisfactory information/ clarification the amendment may be advised.

3. Confirmation of Export Letters of Credit

It constitutes a definite undertaking of the confirming bank, in addition to that of
the issuing bank, which undertakes the sight payment, deferred payment,
acceptance or negotiation.

Banks in India have the facility of covering the credit confirmation risks with
ECGC under their “Transfer Guarantee” scheme and include both the commercial
and political risk involved.
4. Discounting/Negotiation of Export LCs
When the exporter requires funds before due date then he can discount or
negotiate the LCs with the negotiating bank. Once the issuing bank nominates the
negotiating bank, it can take the credit risk on the issuing bank or confirming
bank.

However, in such a situation, the negotiating bank bears the risk associated with
the document that sometimes arises when the issuing bank discover discrepancies
in the documents and refuses to honor its commitment on the due date.

5. Reimbursement of Export LCs

Sometimes reimbursing bank, on the recommendation of issuing bank allows the
negotiating bank to collect the money from the reimbursing bank once the goods
have been shipped. It is quite similar to a cheque facility provided by a bank.
 In return, the reimbursement bank earns a commission per transaction and enjoys
float income without getting involve in the checking the transaction documents.

reimbursement bank play an important role in payment on the due date ( for
usance LCs) or the days on which the negotiating bank demands the same (for
sight LCs)

Regulatory Requirements

Opening of imports LCs in India involve compliance of the following main regulation:

Trade Control Requirements

The movement of good in India is guided by a predefined se of rules and regulation. So,
the banker needs to assure that make certain is whether the goods concerned can be
physically brought in to India or not as per the current EXIM policy.

Exchange Control Requirements

The main objective of a bank to open an Import LC is to effect settlement of payment due
by the Indian importer to the overseas supplier, so opening of LC automatically comes
under the policies of exchange control regulations.

UCPDC Guidelines

Uniform Customs and Practice for Documentary Credit (UCPDC) is a set of predefined
rules established by the International Chamber of Commerce (ICC) on Letters of Credit.
The UCPDC is used by bankers and commercial parties in more than 200 countries
including India to facilitate trade and payment through LC.

UCPDC was first published in 1933 and subsequently updating it throughout the years. In
1994, UCPDC 500 was released with only 7 chapters containing in all 49 articles .

The latest revision was approved by the Banking Commission of the ICC at its meeting in
Paris on 25 October 2006. This latest version, called the UCPDC600, formally
commenced on 1 July 2007. It contain a total of about 39 articles covering the following
areas, which can be classified as 8 sections according to their functions and operational
procedures.

Serial No. Article Area Consisting

Application, Definition and
1. 1 to 3 General
Interpretations
Credit vs. Contracts, Documents
2. 4 to 12 Obligations
vs. Goods
 Reimbursement, Examination of
Liabilities and Documents, Complying,
3. 13 to 16
responsibilities. Presentation, Handling
Discrepant Documents
Bill of Lading, Chapter Party Bill of
Lading, Air Documents, Road Rail
4. 17 to 28 Documents etc. Documents, Courier , Postal etc.
Receipt. On board, Shippers' count,
Clean Documents, Insurance documents
Extension of dates, Tolerance in
Miscellaneous
5. 29 to 33 Credits, Partial Shipment and
Provisions
Drawings. House of Presentation
Effectiveness of Document
Transmission and Translation
6 34 to 37 Disclaimer
Force Majeure
Acts of an Instructed Party
Transferable Credits
7 38 & 39 Others
Assignment of Proceeds

ISBP 2002

The widely acclaimed International Standard Banking Practice(ISBP) for the

Examination of Documents under Documentary Credits was selected in 2007 by the ICCs
Banking Commission.

First introduced in 2002, the ISBP contains a list of guidelines that an examiner needs to
check the documents presented under the Letter of Credit. Its main objective is to reduce
the number of documentary credits rejected by banks.

FEDAI Guidelines

Foreign Exchange Dealer's Association of India (FEDAI) was established in 1958 under
the Section 25 of the Companies Act (1956). It is an association of banks that deals in
Indian foreign exchange and work in coordination with the Reserve Bank of India, other
organizations like FIMMDA, the Forex Association of India and various market
participants.
FEDAI has issued rules for import LCs which is one of the important area of foreign
currency exchanges. It has an advantage over that of the authorized dealers who are now
allowed by the RBI to issue stand by letter of credits towards import of goods.

As the issuance of stand by of letter of Credit including imports of goods is susceptible to

some risk in the absence of evidence of shipment, therefore the importer should be
advised that documentary credit under UCP 500/600 should be the preferred route for
importers of goods.
Below mention are some of the necessary precaution that should be taken by authorised
dealers While issuing a stands by letter of credits:

1. The facility of issuing Commercial Standby shall be extended on a selective basis

and to the following category of importers
1. Where such standby are required by applicant who are independent power
producers/importers of crude oil and petroleum products
2. Special category of importers namely export houses, trading houses, star
trading houses, super star trading houses or 100% Export Oriented Units.
2. Satisfactory credit report on the overseas supplier should be obtained by the
issuing banks before issuing Stands by Letter of Credit.
3. Invocation of the Commercial standby by the beneficiary is to be supported by
proper evidence. The beneficiary of the Credit should furnish a declaration to the
effect that the claim is made on account of failure of the importers to abide by his
contractual obligation along with the following documents.
1. A copy of invoice.
2. Nonnegotiable set of documents including a copy of non negotiable bill of
lading/transport document.
3. A copy of Lloyds /SGS inspection certificate wherever provided for as per
the underlying contract.
4. Incorporation of a suitable clauses to the effect that in the event of such invoice
/shipping documents has been paid by the authorised dealers earlier, Provisions to
dishonor the claim quoting the date / manner of earlier payments of such
documents may be considered.
5. The applicant of a commercial stand by letter of credit shall undertake to provide
evidence of imports in respect of all payments made under standby. (Bill of Entry)

Fixing limits for Commercial Stand by Letter of Credit L/c

1. Banks must assess the credit risk in relation to stand by letter of credit and explain
to the importer about the inherent risk in stand by covering import of goods.
2. Discretionary powers for sanctioning standby letter of credit for import of goods
should be delegated to controlling office or zonal office only.
3. A separate limit for establishing stand by letter of credit is desirable rather than
permitting it under the regular documentary limit.
4. Due diligence of the importer as well as on the beneficiary is essential .
5. Unlike documentary credit, banks do not hold original negotiable documents of
titles to gods. Hence while assessing and fixing credit limits for standby letter of
credits banks shall treat such limits as clean for the purpose of discretionary
lending powers and compliance with various Reserve Bank of India's regulations.
6. Application cum guarantee for stand by letter of credit should be obtained from
the applicant.
7. Banks can consider obtaining a suitable indemnity/undertaking from the importer
that all remittances towards their import of goods as per the underlying contracts
for which stand by letter of credit is issued will be made only through the same
branch which has issued the credit.
 8. The importer should give an undertaking that he shall not raise any dispute
regarding the payments made by the bank in standby letter of credit at any point
of time howsoever, and will be liable to the bank for all the amount paid therein.
He importer should also indemnify the bank from any loss, claim, counter claims,
damages, etc. which the bank may incur on account of making payment under the
stand by letter of credit.
9. Presently, when the documentary letter of credit is established through swift, it is
assumed that the documentary letter of credit is subject to the provisions of
UCPDC 500/600 Accordingly whenever standby letter of credit under ISP 98 is
established through SWIFT, a specific clause must appear that standby letter of
credit is subject to the provision of ISP 98.
10. It should be ensured that the issuing bank, advising bank, nominated bank. etc,
have all subscribed to SP 98 in case stand by letter of credit is issued under ISP
98.
11. When payment under a stand by letter of credit is effected, the issuing bank to
report such invocation / payment to Reserve Bank of India.

In International trade, the buyer and the seller who are located in different countries, may
not know each other and hence many times the problem of Buyer’s Creditworthiness
hampers the trade between the buyer and the seller. The main objectives of the buyer and
the seller in any international trade and contradictory in terms of Buyer will always try to
delay the payment while the seller would like to receive funds at the earliest.

To mitigate this problem, Seller always request Buyer to arrange for a Letter of Credit to
be issued by Buyer’s Bank. Upon issuance of Letter of Credit, the Buyer’s bank replaces
its own Creditworthiness to that of the Buyer, it undertakes to reimburse the Seller for the
value of the Letter of Credit “Irrevocably” provided two underline conditions are fulfilled
by the Seller:

1. All the documents stated in the LC are presented;

2. All the terms and conditions of the LC are complied with.

The beauty of the LC is that if above two conditions are fulfilled, Issuing Bank will effect
payment to the Beneficiary, irrespective of Applicant reimburses the Issuing Bank or not.
Thus, a Letter of Credit is an undertaking issued by a bank in favor of a Beneficiary
(Seller), which substitutes the bank’s creditworthiness for that of the Applicant (Buyer).

Why Letter?

It is named a Letter because initially the LCs were issued manually in a Letter format
address by Issuing Bank to Beneficiary confirming its conditional undertaking to
reimburse the Beneficiary, the amount of the LC provided above 2 basic conditions are
fulfilled.

Parties involved in LC transaction:

 1. The Applicant is the party that arranges for the letter of credit to be issued.
2. The Beneficiary is the party named in the letter of credit in whose favor the letter
of credit is issued.
3. The Issuing or Opening Bank is the applicant’s bank that issues or opens the
letter of credit in favor of the beneficiary and substitutes its creditworthiness for
that of the applicant.
4. An Advising Bank may be named in the letter of credit to advise the beneficiary
that the letter of credit was issued. The role of the Advising Bank is limited to
establish apparent authenticity of the credit, which it advises.
5. The Paying Bank is the bank nominated in the letter of credit that makes payment
to the beneficiary, after determining that documents conform, and upon receipt of
funds from the issuing bank or another intermediary bank nominated by the
issuing bank.
6. The Confirming Bank is the bank, which, under instruction from the issuing
bank, substitutes its creditworthiness for that of the issuing bank. It ultimately
assumes the issuing bank’s commitment to pay.

Letter of Credit Process:

Commercial Letter of Credit Flow

Applicant approaches Issuing/ Opening Bank with LC application form duly filled and
requests Issuing Bank to issue a Letter of Credit in favour of Beneficiary.
 1. Issuing Bank issues a Letter of Credit as per the application submitted by an
Applicant and sends it to the Advising Bank, which is located in Beneficiary’s
country, to formally advise the LC to the beneficiary.
2. Advising Bank advises the LC to the Beneficiary.
3. Once Beneficiary receives the LC and if it suits his/ her requirements, he/ she
prepares the goods and hands over them to the carrier for dispatching to the
Applicant.
4. He/ She then hands over the documents along with the Transport Document as per
LC to the Negotiating Bank to be forwarded to the Issuing Bank.
5. Issuing Bank reimburses the Negotiating Bank with the amount of the LC post
Negotiating Bank’s confirmation that they have negotiated the documents in strict
conformity of the LC terms. Negotiating Bank makes the payment to the
Beneficiary.
6. Simultaneously, the Negotiating Bank forwards the documents to the Issuing
Bank to be released to the Applicant to claim the goods from the carrier.
7. Applicant reimburses the Issuing Bank for the amount, which it had paid to the
Negotiating Bank.
8. Issuing Bank releases all documents along with the titled Transport Documents to
the Applicant.

Settlements Under a Letter of Credit

All commercial letters of credit must clearly indicate whether they are payable by sight
payment, by deferred payment, by acceptance, or by negotiation. These are noted as
formal demands under the terms of the commercial letter of credit.
In a sight payment, the commercial letter of credit is payable when the beneficiary
presents the complying documents and if the presentation takes place on or before the
expiration of the commercial letter of credit.

In a deferred payment, the commercial letter of credit is payable on a specified future

date. The beneficiary may present the complying documents at an earlier date, but the
commercial letter of credit is payable only on the specified future date.

An acceptance is a time draft drawn on, and accepted by, a banking institution, which
promises to honor the draft at a specified future date. The act of acceptance is without
recourse as it is a commitment to pay the face amount of the accepted draft.

Under negotiation, the negotiating bank, a third party negotiator, expedites payment to
the beneficiary upon the beneficiary’s presentation of the complying documents to the
negotiating bank. The bank pays the beneficiary, normally at a discount of the face
amount of the value of the documents, and then presents the complying documents,
including a sight or time draft, to the issuing bank to receive full payment at sight or at a
specified future date.

Types of Letter of Credit

Irrevocable

An irrevocable letter of credit can neither be amended nor cancelled without the
agreement of all parties to the credit. Under UCP500 all letters of credit are deemed to be
irrevocable unless otherwise stated. Here, the importer's bank gives a binding undertaking
to the supplier provided all the terms and conditions of the credit are fulfilled.

Unconfirmed

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.

Confirmed

A confirmed letter of credit is one in which the advising bank, on the instructions of the
issuing bank, has added a confirmation that payment will be made as long as compliant
documents are presented. This commitment holds even if the issuing bank or the buyer
fails to make payment. The added security to the exporter of confirmation needs to be
considered in the context of the standing of the issuing bank and the current political and
economic state of the importer's country. A bank will make an additional charge for
confirming a letter of credit. In many cases, the confirming bank is located in
Beneficiary’s country.
Confirmation costs will vary according to the country involved, but for many countries
considered a high risk will be between 2%-8%. There also may be countries issuing
letters of credit, which banks do not wish to confirm - they may already have enough
exposure in that market or not wish to expose themselves to that particular risk at all.

Standby Letters of Credit

A standby letter of credit is used as support where an alternative, less secure, method of
payment has been agreed. They are also used in the United States of America in place of
bank guarantees. Should the exporter fail to receive payment from the importer he may
claim under the standby letter of credit. Certain documents are likely to be required to
obtain payment including: the standby letter of credit itself; a sight draft for the amount
due; a copy of the unpaid invoice; proof of dispatch and a signed declaration from the
beneficiary stating that payment has not been received by the due date and therefore
reimbursement is claimed by letter of credit. The International Chamber of Commerce
publishes rules for operating standby letters of credit - ISP98 International Standby
Practices.

Revolving Letter of Credit

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 time revolving once
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. The credit must state that it is a revolving letter of credit and it may
revolve either automatically or subject to certain provisions. Revolving letters of credit
are useful to avoid the need for repetitious arrangements for opening or amending letters
of credit.

Transferable Letter of Credit

A transferable letter of credit is one in which the exporter has the right to request the
paying, or negotiating bank to make either part, or all, of the credit value available to one
or more third parties. This type of credit is useful for those acting as middlemen
especially where there is a need to finance purchases from third party suppliers.

Back-to-Back Letter of Credit

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.

Advantages of Letter of Credit:

1. The beneficiary is assured of payment as long as it complies with the terms and
conditions of the letter of credit. The letter of credit identifies which documents
must be presented and the data content of those documents. The credit risk is
transferred from the applicant to the issuing bank.
2. The beneficiary can enjoy the advantage of mitigating the issuing bank’s country
risk by requiring that a bank in its own country confirm the letter of credit. That
bank then takes on the country and commercial risk of the issuing bank and
protects the beneficiary.
3. The beneficiary minimizes collection time as the letter of credit accelerates
payment of the receivables.
4. The beneficiary’s foreign exchange risk is eliminated with a letter of credit issued
in the currency of the beneficiary’s country.

Risks involved in Letter of Credit.

1. Since all the parties involved in Letter of Credit deal with the documents and not
with the goods, the risk of Beneficiary not shipping goods as mentioned in the LC
is still persists.
2. The Letter of Credit as a payment method is costlier than other methods of
payment such as Open Account or Collection
 3. The Beneficiary’s documents must comply with the terms and conditions of the
Letter of Credit for Issuing Bank to make the payment.
4. The Beneficiary is exposed to the Commercial risk on Issuing Bank, Political risk
on the Issuing Bank’s country and Foreign Exchange Risk in case of Usance
Letter of Credits.

Understanding and Using Letters of Credit, Part I

Letters of credit accomplish their purpose by substituting the credit of the bank for that of
the customer, for the purpose of facilitating trade. There are basically two types:
commercial and standby. The commercial letter of credit is the primary payment
mechanism for a transaction, whereas the standby letter of credit is a secondary payment
mechanism.

Commercial Letter of Credit

Commercial letters of credit have been used for centuries to facilitate payment in
international trade. Their use will continue to increase as the global economy evolves.

Letters of credit used in international transactions are governed by the International

Chamber of Commerce Uniform Customs and Practice for Documentary Credits. The
general provisions and definitions of the International Chamber of Commerce are binding
on all parties. Domestic collections in the United States are governed by the Uniform
Commercial Code.

A commercial letter of credit is a contractual agreement between a bank, known as the

issuing bank, on behalf of one of its customers, authorizing another bank, known as the
advising or confirming bank, to make payment to the beneficiary. The issuing bank, on
the request of its customer, opens the letter of credit. The issuing bank makes a
commitment to honor drawings made under the credit. The beneficiary is normally the
provider of goods and/or services. Essentially, the issuing bank replaces the bank's
customer as the payee.

Elements of a Letter of Credit

• A payment undertaking given by a bank (issuing bank)

• On behalf of a buyer (applicant)
• To pay a seller (beneficiary) for a given amount of money
• On presentation of specified documents representing the supply of goods
• Within specified time limits
• Documents must conform to terms and conditions set out in the letter of credit
• Documents to be presented at a specified place

Beneficiary
The beneficiary is entitled to payment as long as he can provide the documentary
evidence required by the letter of credit. The letter of credit is a distinct and separate
transaction from the contract on which it is based. All parties deal in documents and not
in goods. The issuing bank is not liable for performance of the underlying contract
between the customer and beneficiary. The issuing bank's obligation to the buyer, is to
examine all documents to insure that they meet all the terms and conditions of the credit.
Upon requesting demand for payment the beneficiary warrants that all conditions of the
agreement have been complied with. If the beneficiary (seller) conforms to the letter of
credit, the seller must be paid by the bank.

Issuing Bank
The issuing bank's liability to pay and to be reimbursed from its customer becomes
absolute upon the completion of the terms and conditions of the letter of credit. Under the
provisions of the Uniform Customs and Practice for Documentary Credits, the bank is
given a reasonable amount of time after receipt of the documents to honor the draft.

The issuing banks' role is to provide a guarantee to the seller that if compliant documents
are presented, the bank will pay the seller the amount due and to examine the documents,
and only pay if these documents comply with the terms and conditions set out in the letter
of credit.

Typically the documents requested will include a commercial invoice, a transport

document such as a bill of lading or airway bill and an insurance document; but there are
many others. Letters of credit deal in documents, not goods.

Advising Bank
An advising bank, usually a foreign correspondent bank of the issuing bank will advise
the beneficiary. Generally, the beneficiary would want to use a local bank to insure that
the letter of credit is valid. In addition, the advising bank would be responsible for
sending the documents to the issuing bank. The advising bank has no other obligation
under the letter of credit. If the issuing bank does not pay the beneficiary, the advising
bank is not obligated to pay.

Confirming Bank
The correspondent bank may confirm the letter of credit for the beneficiary. At the
request of the issuing bank, the correspondent obligates itself to insure payment under the
letter of credit. The confirming bank would not confirm the credit until it evaluated the
country and bank where the letter of credit originates. The confirming bank is usually the
advising bank.

Letter of Credit Characteristics

Negotiability
Letters of credit are usually negotiable. The issuing bank is obligated to pay not only the
beneficiary, but also any bank nominated by the beneficiary. Negotiable instruments are
passed freely from one party to another almost in the same way as money. To be
negotiable, the letter of credit must include an unconditional promise to pay, on demand
or at a definite time. The nominated bank becomes a holder in due course. As a holder in
due course, the holder takes the letter of credit for value, in good faith, without notice of
any claims against it. A holder in due course is treated favorably under the UCC.

The transaction is considered a straight negotiation if the issuing bank's payment

obligation extends only to the beneficiary of the credit. If a letter of credit is a straight
negotiation it is referenced on its face by "we engage with you" or "available with
ourselves". Under these conditions the promise does not pass to a purchaser of the draft
as a holder in due course.

Revocability
Letters of credit may be either revocable or irrevocable. A revocable letter of credit may
be revoked or modified for any reason, at any time by the issuing bank without
notification. A revocable letter of credit cannot be confirmed. If a correspondent bank is
engaged in a transaction that involves a revocable letter of credit, it serves as the advising
bank.

Once the documents have been presented and meet the terms and conditions in the letter
of credit, and the draft is honored, the letter of credit cannot be revoked. The revocable
letter of credit is not a commonly used instrument. It is generally used to provide
guidelines for shipment. If a letter of credit is revocable it would be referenced on its
face.

The irrevocable letter of credit may not be revoked or amended without the agreement of
the issuing bank, the confirming bank, and the beneficiary. An irrevocable letter of credit
from the issuing bank insures the beneficiary that if the required documents are presented
and the terms and conditions are complied with, payment will be made. If a letter of
credit is irrevocable it is referenced on its face.

Transfer and Assignment

The beneficiary has the right to transfer or assign the right to draw, under a credit only
when the credit states that it is transferable or assignable. Credits governed by the
Uniform Commercial Code (Domestic) maybe transferred an unlimited number of times.
Under the Uniform Customs Practice for Documentary Credits (International) the credit
may be transferred only once. However, even if the credit specifies that it is
nontransferable or nonassignable, the beneficiary may transfer their rights prior to
performance of conditions of the credit.

Sight and Time Drafts

All letters of credit require the beneficiary to present a draft and specified documents in
order to receive payment. A draft is a written order by which the party creating it, orders
another party to pay money to a third party. A draft is also called a bill of exchange.

There are two types of drafts: sight and time. A sight draft is payable as soon as it is
presented for payment. The bank is allowed a reasonable time to review the documents
before making payment.
A time draft is not payable until the lapse of a particular time period stated on the draft.
The bank is required to accept the draft as soon as the documents comply with credit
terms. The issuing bank has a reasonable time to examine those documents. The issuing
bank is obligated to accept drafts and pay them at maturity.

Standby Letter of Credit

The standby letter of credit serves a different function than the commercial letter of
credit. The commercial letter of credit is the primary payment mechanism for a
transaction. The standby letter of credit serves as a secondary payment mechanism. A
bank will issue a standby letter of credit on behalf of a customer to provide assurances of
his ability to perform under the terms of a contract between the beneficiary. The parties
involved with the transaction do not expect that the letter of credit will ever be drawn
upon.

The standby letter of credit assures the beneficiary of the performance of the customer's
obligation. The beneficiary is able to draw under the credit by presenting a draft, copies
of invoices, with evidence that the customer has not performed its obligation. The bank is
obligated to make payment if the documents presented comply with the terms of the letter
of credit.

Standby letters of credit are issued by banks to stand behind monetary obligations, to
insure the refund of advance payment, to support performance and bid obligations, and to
insure the completion of a sales contract. The credit has an expiration date.

The standby letter of credit is often used to guarantee performance or to strengthen the
credit worthiness of a customer. In the above example, the letter of credit is issued by the
bank and held by the supplier. The customer is provided open account terms. If payments
are made in accordance with the suppliers' terms, the letter of credit would not be drawn
on. The seller pursues the customer for payment directly. If the customer is unable to pay,
the seller presents a draft and copies of invoices to the bank for payment.

The domestic standby letter of credit is governed by the Uniform Commercial Code.
Under these provisions, the bank is given until the close of the third banking day after
receipt of the documents to honor the draft.

Procedures for Using the Tool

The following procedures include a flow of events that follow the decision to use a
Commercial Letter of Credit. Procedures required to execute a Standby Letter of Credit
are less rigorous. The standby credit is a domestic transaction. It does not require a
correspondent bank (advising or confirming). The documentation requirements are also
less tedious.

Step-by-step process:

• Buyer and seller agree to conduct business. The seller wants a letter of credit to
guarantee payment.
 • Buyer applies to his bank for a letter of credit in favor of the seller.
• Buyer's bank approves the credit risk of the buyer, issues and forwards the credit
to its correspondent bank (advising or confirming). The correspondent bank is
usually located in the same geographical location as the seller (beneficiary).
• Advising bank will authenticate the credit and forward the original credit to the
seller (beneficiary).
• Seller (beneficiary) ships the goods, then verifies and develops the documentary
requirements to support the letter of credit. Documentary requirements may vary
greatly depending on the perceived risk involved in dealing with a particular
company.
• Seller presents the required documents to the advising or confirming bank to be
processed for payment.
• Advising or confirming bank examines the documents for compliance with the
terms and conditions of the letter of credit.
• If the documents are correct, the advising or confirming bank will claim the funds
by:
o Debiting the account of the issuing bank.
o Waiting until the issuing bank remits, after receiving the documents.
o Reimburse on another bank as required in the credit.
• Advising or confirming bank will forward the documents to the issuing bank.
• Issuing bank will examine the documents for compliance. If they are in order, the
issuing bank will debit the buyer's account.
• Issuing bank then forwards the documents to the buyer.

Standard Forms of Documentation

When making payment for product on behalf of its customer, the issuing bank must
verify that all documents and drafts conform precisely to the terms and conditions of the
letter of credit. Although the credit can require an array of documents, the most common
documents that must accompany the draft include:

Commercial Invoice
The billing for the goods and services. It includes a description of merchandise, price,
FOB origin, and name and address of buyer and seller. The buyer and seller information
must correspond exactly to the description in the letter of credit. Unless the letter of credit
specifically states otherwise, a generic description of the merchandise is usually
acceptable in the other accompanying documents.

Bill of Lading
A document evidencing the receipt of goods for shipment and issued by a freight carrier
engaged in the business of forwarding or transporting goods. The documents evidence
control of goods. They also serve as a receipt for the merchandise shipped and as
evidence of the carrier's obligation to transport the goods to their proper destination.

Warranty of Title
A warranty given by a seller to a buyer of goods that states that the title being conveyed
is good and that the transfer is rightful. This is a method of certifying clear title to product
transfer. It is generally issued to the purchaser and issuing bank expressing an agreement
to indemnify and hold both parties harmless.

Letter of Indemnity
Specifically indemnifies the purchaser against a certain stated circumstance.
Indemnification is generally used to guaranty that shipping documents will be provided in
good order when available.

Common Defects in Documentation

About half of all drawings presented contain discrepancies. A discrepancy is an
irregularity in the documents that causes them to be in non-compliance to the letter of
credit. Requirements set forth in the letter of credit cannot be waived or altered by the
issuing bank without the express consent of the customer. The beneficiary should prepare
and examine all documents carefully before presentation to the paying bank to avoid any
delay in receipt of payment. Commonly found discrepancies between the letter of credit
and supporting documents include:

• Letter of Credit has expired prior to presentation of draft.

• Bill of Lading evidences delivery prior to or after the date range stated in the
credit.
• Stale dated documents.
• Changes included in the invoice not authorized in the credit.
• Inconsistent description of goods.
• Insurance document errors.
• Invoice amount not equal to draft amount.
• Ports of loading and destination not as specified in the credit.
• Description of merchandise is not as stated in credit.
• A document required by the credit is not presented.
• Documents are inconsistent as to general information such as volume, quality, etc.
• Names of documents not exact as described in the credit. Beneficiary information
must be exact.
• Invoice or statement is not signed as stipulated in the letter of credit.

When a discrepancy is detected by the negotiating bank, a correction to the document

may be allowed if it can be done quickly while remaining in the control of the bank. If
time is not a factor, the exporter should request that the negotiating bank return the
documents for corrections.

If there is not enough time to make corrections, the exporter should request that the
negotiating bank send the documents to the issuing bank on an approval basis or notify
the issuing bank by wire, outline the discrepancies, and request authority to pay. Payment
cannot be made until all parties have agreed to jointly waive the discrepancy.

Tips for Exporters

• Communicate with your customers in detail before they apply for letters of credit.
 • Consider whether a confirmed letter of credit is needed.
• Ask for a copy of the application to be fax to you, so you can check for terms or
conditions that may cause you problems in compliance.
• Upon first advice of the letter of credit, check that all its terms and conditions can
be complied with within the prescribed time limits.
• Many presentations of documents run into problems with time-limits. You must
be aware of at least three time constraints - the expiration date of the credit, the
latest shipping date and the maximum time allowed between dispatch and
presentation.
• If the letter of credit calls for documents supplied by third parties, make
reasonable allowance for the time this may take to complete.
• After dispatch of the goods, check all the documents both against the terms of the
credit and against each other for internal consistency.

Summary
The use of the letters of credit as a tool to reduce risk has grown substantially over the
past decade. Letters of credit accomplish their purpose by substituting the credit of the
bank for that of the customer, for the purpose of facilitating trade.

The credit professional should be familiar with two types of letters of credit: commercial
and standby. Commercial letters of credit are used primarily to facilitate foreign trade.
The commercial letter of credit is the primary payment mechanism for a transaction.

The standby letter of credit serves a different function. The standby letter of credit serves
as a secondary payment mechanism. The bank will issue the credit on behalf of a
customer to provide assurances of his ability to perform under the terms of a contract.

Upon receipt of the letter of credit, the credit professional should review all items
carefully to insure that what is expected of the seller is fully understood and that he can
comply with all the terms and conditions. When compliance is in question, the buyer
should be requested to amend the credit.

FAQ: Capital a/c convertibility and how it affects you

Last updated on: September 04, 2006 18:34 IST

Email
this

Save to
My Page

Ask
Users

Write a
Comment
India has been relentlessly moving on the path towards liberalization, opening up its
markets and loosening its controls over many economic matters so as to integrate with the
global economy.

Despite the opposition to globalization from some quarters, India has been quite watchful
in its approach to embracing global economy. The issue of capital account convertibility
is one such where the nation has tread very cautiously.

A high-level committee to look into this matter, appointed by the Reserve Bank of India [
Get Quote ], on Friday recommended that India move to fuller capital account
convertibility over the next five years and has laid down the roadmap for the move.

So what is capital account convertibility?

To put is simply, capital account convertibility (CAC) -- or a floating exchange rate --

means the freedom to convert local financial assets into foreign financial assets and vice
versa at market determined rates of exchange. This means that capital account
convertibility allows anyone to freely move from local currency into foreign currency and
back.

It refers to the removal of restraints on international flows on a country's capital account,

enabling full currency convertibility and opening of the financial system.

A capital account refers to capital transfers and acquisition or disposal of non-produced,

non-financial assets, and is one of the two standard components of a nation's balance of
payments. The other being the current account, which refers to goods and services,
income, and current transfers.

How are capital a/c convertibility and current a/c convertibility different?

Current account convertibility allows free inflows and outflows for all purposes other
than for capital purposes such as investments and loans. In other words, it allows
residents to make and receive trade-related payments -- receive dollars (or any other
foreign currency) for export of goods and services and pay dollars for import of goods
and services, make sundry remittances, access foreign currency for travel, studies abroad,
medical treatment and gifts, etc.

Why capital account convertibility?

Capital account convertibility is considered to be one of the major features of a developed

economy. It helps attract foreign investment. It offers foreign investors a lot of comfort as
they can re-convert local currency into foreign currency anytime they want to and take
their money away.
At the same time, capital account convertibility makes it easier for domestic companies to
tap foreign markets. At the moment, India has current account convertibility. This means
one can import and export goods or receive or make payments for services rendered.
However, investments and borrowings are restricted.

But economists say that jumping into capital account convertibility game without
considering the downside of the step could harm the economy. The East Asian economic
crisis is cited as an example by those opposed to capital account convertibility.

Even the World Bank has said that embracing capital account convertibility without
adequate preparation could be catastrophic. But India is now on firm ground given its
strong financial sector reform and fiscal consolidation, and can now slowly but steadily
move towards fuller capital account convertibility.

What is the Tarapore Committee?

The Reserve Bank of India has appointed a committee to set out the framework for fuller
Capital Account Convertibility.

The Committee, chaired by former RBI governor S S Tarapore, was set up by the
Reserve Bank of India in consultation with the Government of India to revisit the subject
of fuller capital account convertibility in the context of the progress in economic reforms,
the stability of the external and financial sectors, accelerated growth and global
integration.

Economists Surjit S Bhalla, M G Bhide, R H Patil, A V Rajwade and Ajit Ranade were
the members of the Committee.

The Reserve Bank of India has also constituted an internal task force to re-examine the
extant regulations and make recommendations to remove the operational impediments in
the path of liberalisation already in place. The task force will make its recommendations
on an ongoing basis and the processes are expected to be completed by December 4,
2006. The Task Force has been set up following a recommendation of the Committee.

The Task Force will be convened by Salim Gangadharan, chief general manager, in-
charge, foreign exchange department, Reserve Bank of India, and will have the following
terms of reference:

• Undertake a review of the extant regulations that straddle current and capital
accounts, especially items in one account that have implication for the other
account, and iron out inconsistencies in such regulations.
• Examine existing repatriation/surrender requirements in the context of current
account convertibility and management of capital account.
• Identify areas where streamlining and simplification of procedure is possible and
remove the operational impediments, especially in respect of the ease with which
 transactions at the level of authorized entities are conducted, so as to make
liberalisation more meaningful.
• Ensure that guidelines and regulations are consistent with regulatory intent.
• Review the delegation of powers on foreign exchange regulations between
Central Office and Regional offices of the RBI and examine, selectively, the
efficacy in the functioning of the delegation of powers by RBI to Authorised
Dealers (banks).
• Consider any other matter of relevance to the above.

The Task Force is empowered to devise its work procedure, constitute working groups in
various areas, co-opt permanent/special invitees and meet various trade associations,
representative bodies or individuals to facilitate its work. It will make recommendations
on an ongoing basis to rectify the anomalies and remove operational impediments. The
processes are expected to be completed by December 4, 2006.

How does capital a/c convertibility affect you?

As most of us know, resident Indians cannot move their money abroad freely. That is,
one has to operate within the limits specified by the Reserve Bank of India and obtain
permission from RBI for anything concerning foreign currency.

For example, the annual limit for the amount you are allowed to carry on a private visit
abroad is $10,000: of which only $5,000 can be in cash. For business travel, the yearly
limit is $25,000. Similarly, you can gift or donate up to $5,000 in a year.

The RBI limit raises the limit if you are going abroad for employment, or are emigrating
to another country, or are going for studies abroad: the limit in both these cases is
$100,000.

You are also allowed to invest into foreign stock markets up to the extent of $25,000 in a
year.

For the average Indian, these 'limits' seem generous and might not affect him at all. But
for heavy spenders and those with visions of buying a house abroad or a Van Gogh
painting, it will mean a lot. . .

But with the markets opening up further with the advent of capital account convertibility,
one would be able to look forward to more and better goods and services.

And how will it affect Non-Resident Indians?

Capital account convertibility may NRIs as it will help remove all shackles on movement
of their funds.

Currently, NRIs have to produce a whole lot of documents and certificates if they want to
buy a house in India (for which the lock-in period is 10 years, meaning they can't take
their money back overseas if they sell the house after having owned it for less than 10
years), or send money to India from their overseas accounts.

NRIs: Tax benefits may be removed

However, the Tarapore Committee on fuller capital account convertibility has

recommended bringing foreign individuals on par with Non-Resident Indians in terms of
convertibility and tax treatment.

The committee has proposed that the government must review tax benefits offered to
NRIs for investments in foreign currency non-resident (banks) and non-resident
(external) rupee account deposit schemes, while suggesting that foreign individuals be
allowed to invest in these deposit schemes but without any tax concessions.

The committee said a movement towards capital account convertibility implied that all
non-residents (corporates and individuals) should get equal treatment. This means that the
tax benefits extended to NRIs under these schemes should be removed.

The committee recommends that these deposit schemes should be extended to non-
residents (other than NRIs), in two phases.

In Phase I, non-residents could first be provided the FCNR (B) deposit facility, without
tax benefits, subject to know-your-customer (customer identification) and financial action
task force's (FATF) anti-money laundering norms.

Similarly, in Phase II, the NR(E)RA deposit scheme, with cheque writing facility, could
also be extended to non-residents.

With respect to the capital market, at present only NRIs are allowed to invest in
companies listed on the Indian stock exchanges, subject to certain stipulations.

The committee said all individual non-residents and non-resident corporates should be
allowed to invest in the Indian stock market through Sebi-registered entities, including
mutual funds and portfolio management schemes.

These entities will be responsible for meeting KYC and FATF norms and the money
should come through bank accounts in India.

The committee has also recommended that the resident foreign currency (RFC) and RFC
(deposit) accounts should be merged. The account holders should be allowed to move
foreign currency balances to overseas banks.

For those wishing to continue with the RFC accounts, foreign currency current/savings
chequable accounts should be provided, in addition to the foreign currency term deposits.
_____________________________________________________________

Before the voyages of discovery, the earth was believed to be flat, such that people feared
that once one reached the end of the world, one would fall off the edge of the Earth.
Soon, it was discovered that the Earth was actually a sphere and one could safely go
around it. However, more recently, the Earth is said to be becoming flat again, a theory
propounded by Thomas Friedman in his bestseller book ‘The World is Flat’. The forces
of Globalization and Liberalization are cutting across borders, re-integrating the world
towards a common goal of development. The liberalization reforms which swept across
the country in 1991 changed the face of the Indian economy.

The results are paying off and India has witnessed exceptional growth rates of 9.6% and
9.4% in 2006 and 2007, respectively.

Thus, in the current stream of events, where globalization has become the ‘hot’ word and
financial liberalization is synonymous with ‘developed economies’, the key issue that is to
be considered, is whether India is ready to take the plunge towards Full Capital Account
Convertibility (FCAC).

Capital Account Convertibility (CAC) is the freedom to convert local financial assets into
foreign financial assets at market determined exchange rates. Referred to as ‘Capital Asset
Liberation’ in foreign countries, it implies free exchangeability of currency at lower rates
and an unrestricted mobility of capital. India presently has current account convertibility,
which means that foreign exchange is easily available for import and export for goods
and services. India also has partial capital account convertibility; such that an Indian
individual or an institution can invest in foreign assets upto $25000. Foreigners can also
invest along the same lines. At present, there are limits on investment by foreign financial
investors and also caps on FDI ceiling in most sectors, for example, 74% in banking and
communication, 49% in insurance, 0% in retail, etc.

The First Tarapore Committee was set up by the RBI in 1997 to study the implications of
executing CAC in India. It recommended that the before CAC is implemented, the fiscal
deficit needs to be reduced to 3.5% of the GDP, inflation rates need to be controlled
between 3-5%, the non-performing assets (NPAs) need to be brought down to 5%, Cash
Reserve Ratio (CRR) needs to be reduced to 3%, and a monetary exchange rate band of
plus minus 5% should be instituted. However, most of the pre-conditions weren’t entirely
fulfilled. Thus, CAC was abandoned for the moment.

However, recently there has been a renewed optimism as some of the targets suggested
by the First Tarapore Committee have been achieved. Moreover, consolidation of banks, a
strong export front, large forex

reserves amounting to $300 billion and high growth rates have also instilled within, some
hope. Thus, a Second Tarapore Committee was set up in 2006 to look into the PM’s
proposal to reevaluate the earlier stand. Although the report hasn’t been released yet, the
committee does plan to increase the threshold level for investments from $25000 to
$200000 in 3 phases.

CAC can be beneficial for a country as the inflow of foreign investment increases and the
transactions are much easier and occur at a faster pace. CAC also initiates risk spreading
through diversification of portfolios. Moreover, countries gain access to newer
technologies which translate into further development and higher growth rates.

Even though CAC seems to have many advantages, in reality, it can actually destabilize
the economy through massive capital flight from a country. Not only are there dangerous
consequences associated with capital outflow, excessive capital inflow can cause
currency appreciation and worsening of the Balance of Trade. Furthermore, there are
overseas credit risks and fears of speculation. In addition, it is believed that CAC
increases short term FIIs more than long term FDIs, thus leading to volatility in the
system.

However, if we were to judge the implications of CAC in India, independent of its

general pros and cons, CAC may not be such a good idea in the near future. The
instability in the international markets due to the sub prime crisis and fears of a US
recession are adversely affecting the entire world, including India. Moreover, rising oil
prices which touched $100 a barrel recently are also fueling inflationary pressures in the
economies, worldwide.

Not only is there instability in the international arena, but India’s domestic economy is
also going through ups and downs. The rising prices and the appreciation of the rupee are
adversely affecting India’s exports and the Balance of Trade. Moreover, the fiscal deficit
has been highly underestimated by ignoring the deficits of individual states and through
issuance of oil bonds to the public sector oil companies, making severe losses due to the
heavy subsidies on oil. The government is yet to compensate these companies and these
deferred payments have been left out from the deficit. Also, corruption, bureaucracy, red
tapism and in general, a poor business environment, are discouraging the inflow of
investment. Poor infrastructure and socio-economic backwardness act as deterrents to
FDI inflow.

Hence, India still needs to work on its fundamentals of providing universal quality
education and health services and empowerment of marginalized groups, etc. The growth
strategy needs to be more inclusive. There is no point trying to add on to the clump at the
top of the pyramid if the base is too weak. The pyramid will soon collapse! Thus, before
opening up to financial volatility through the implementation of FCAC, India needs to
strengthen its fundamentals and develop a strong base.

Hence, India should either wait for a while or implement CAC in a phased, gradual and
cautious manner.

Sukanya Garg