Risks in Foreign Trade

Businesses conducting export-import trade face a number of risks that may adversely impact their operations, such as the following:

• Political risk: Actions of legitimate government authorities to confiscate cargo, war, revolution, terrorism, and strikes that impede the conduct of international business
• Foreign credit risk: Nonpayment or delays in payment for imports
• Transportation risk: Loss (partial/total) or damage to shipment during transit
• Foreign exchange/transfer risk: Depreciation of overseas customer’s currency against the exporter’s currency before payment or the nonavailability of foreign currency for payment in the buyer’s country.

1. Political Risks

Many export-import businesses are potentially exposed to various types of political risks. Wars, revolution, or civil unrest can lead to destruction or confiscation of cargo. A gov­ernment may impose severe restrictions on export-import trade, such as limitations on or control of exports or imports, restrictions on licenses, currency controls, and so on. Even though such risks are less likely in Western countries, they occur quite frequently in certain developing nations. Such risks can be managed by taking the following steps.

1.1. Monitoring Political Developments

Private firms offer monitoring assistance to assess the likelihood of political instability in the short and medium term. Such information can be obtained from specialized sources for specific countries such as political risk services (e.g., Political Risk Services of Syracuse, a unit of International Business Communications), the Economic Intelligence Unit, Euromoney, and Business International Corporation. Public agencies such as the Export-Import Bank of the United States (Eximbank) and the Department of Commerce also provide country risk reports.

1.2. Insuring Against Political Risks

Most industrialized nations provide insurance programs for their export firms to cover losses due to political risks. In the United States, Eximbank offers a wide range of policies to ac­commodate many different insurance needs of exporters. Private insurers cover ordinary commercial risk, but Eximbank assumes all liability for political risks. (See Chapter 14 on government export financing.)

2. Foreign Credit Risks

A significant percentage of export trade is conducted on credit. It is estimated that about 35 to 50 percent of exports of the United States and the United Kingdom are sold on open account and/or consignment (Seyoum and Morris, 1996). This means that the risk of delays in payment or nonpayment could have a crucial effect on cash flow and profits. Payment periods vary across countries, and even for countries that have close economic relations, such as those in the European Union, payment periods range from forty-eight days in the Netherlands to ninety days in Italy. Payments are, on average, eighteen days overdue in Ger­many, twenty-three in the United Kingdom, nineteen in France, and twenty in Italy (Luesby, 1994). Payment practices appear to be a function of the global/local economic conditions as well as the local business culture. In many developing countries, delays may be due to foreign exchange shortages, which in turn result in delays by central banks in converting lo­cal currencies into foreign exchange. The likelihood of bad debt from an overseas customer (0.5 percent of sales) is generally less than that for an American company. However, this does not provide comfort to an exporter whose cash flow and profit could be adversely affected by late payments and default. Beans Industries, once part of the British Leyland group, which makes automotive components, was taken into receivership in 1994 due to bad debts and late payments that had a dramatic effect on cash flow, despite increased demand for its products (Cheeseright, 1994). A default by an overseas customer is still costly even when the exporter has insurance to cover commercial credit risks. The exporter must follow strict procedures to obtain payment before insurance claims will be honored. The following measures will help export companies in dealing with problems of defaults and/or delays in payment.

2.1. Appropriate Credit Management

Appropriate credit management involves the review of credit decisions based on current and reliable credit reports on overseas customers. Credit reports on foreign companies can be obtained from international banks that have affiliates in various countries and private credit information sources such as Dunn and Bradstreet, Graydon America, Owens Online, TRW Credit Services, and the National Association of Credit Management Corporation (NACM). A number of foreign credit information firms also provide accurate and reliable information on overseas customers. Government agencies such as the U.S. Department of Commerce, Eximbank, and the Foreign Credit Insurance Association (FCIA) also offer credit reporting services on foreign firms. Export firms also need to have a formal credit policy that will help them recover overdue or bad debts and substantially reduce the occurrence of such risks in future.

2.2. Requiring Letters of Credit and Other Conditions

A confirmed, irrevocable letter-of-credit transaction avoids risks arising from late payments or bad debts because it ensures that payments are made before the goods are shipped to the importer. However, such requirements (including advanced payments before shipment) do not attract many customers, and exporters seeking to develop overseas markets often have to sell on open account or consignment to enable the foreign wholesaler or retailer to pay only after the goods have been sold. The exporter can also require the payment of interest when payment is not made within the time period agreed or, failing that, within a given number of days. The introduction of a similar measure in Sweden in the mid-1970s is believed to have substantially reduced the delinquency of late payments to fewer than seven days. The European Commission submitted a draft recommendation to discourage late payments in cross-border trade (European Commission, 1994). Another safeguard would be to secure collateral to cover a transaction.

2.3. Insuring Against Credit Risks

Many export firms do not insure trade receivables, and yet, such cover is as necessary as fire or car insurance. It is estimated that in most developed countries, fewer than 20 percent of trade debts are insured. Credit insurers tend to have extensive databases that allow them to assess the creditworthiness of an insured’s customer. This helps export companies to distinguish those buyers with the money to pay for their orders from those that are likely to delay payments or default. A credit insurance policy also provides confidence to the lender and may help exporters obtain a wide range of banking services and an improved rate of borrowing.

Few private insurance firms cover foreign credit risk; American Credit Indemnity, Con­tinental Credit Insurance, Fidelity and Deposit Company, and American Insurance Under­writers are among those that provide such coverage. Such firms could be contacted directly or through brokers stationed in various parts of the country. Policies often cover commercial and political risks, although, in some cases, they are limited to insolvency and protracted de­fault in eligible countries. Minimum premiums range from $1,250 to $10,000 per policy year.

Eximbank provides various types of credit insurance policies: credit insurance for small businesses (umbrella policy, small-business policy), single and multibuyer policies, Overseas Private Investment Corporation policies, bank letter-of-credit policies, and so on. Its major features are U.S. content requirements and restrictions on sales destined for military use or to communist nations. (See Chapter 14, “Government Export Financing Programs.”)

3. Foreign Exchange Risks

Export-import firms are vulnerable to foreign exchange risks whenever they enter into an obligation to accept or deliver a specified amount of foreign currency at a future point in time. These firms could face a possibility that changes in foreign currency values could either reduce their future receipts or increase their payments in the foreign currency. Different methods are used to protect against such risks, for example, shifting the risk to third parties or to the other party in an export contract (for details, see Chapter 10 on exchange rates and trade).

Source: Seyoum Belay (2014), Export-import theory, practices, and procedures, Routledge; 3rd edition.