Payments in international trade are generally made through bills of exchange and banker’s drafts.
A bill of exchange is an order drawn by a person upon a bank or another person asking the latter to make certain payments to a third party.
Suppose, that an Indian Jute merchant Shanker has exported Jute of the value of Rs. 1,00,000 to an English merchant Arther. Also another Indian merchant Sinha has imported textiles of the value of Rs. 1,00,000 from Philip an English merchant. If the transactions are settled by Arther by sending gold to Shanker and by Sinha sending gold to Phillip that would mean double expenditure in the cost of carriage. But suppose that the Indian exporter draws a bill on the English importer and sells it to the Indian importer.
The Indian importer in his turn, buys the bill and sends it to the English exporter who presents it to the English importer and receives payments from him. Thus, without any movement of money the two debts are settled by one bill. This is the way by which bills are used to finance foreign trade.
In recent times the use of bills is decreasing and settlements are now made by means of banker’s drafts or cable transfers (in the case of urgent payments). The importer goes to a bank, buys a draft and sends it to the exporter. The latter presents it for payment to foreign branch or agent to the bank.
Bills may be “Sight” or “Long” bills. A sight bill is a bill payable at sight i.e., on presentation. A Long bill is payable after a certain period mostly 90 days after presentation.
If the importer or an accepting house on his behalf writes the word “accepted” on the face of the bill and signs his name the bill is said to be “accepted”. The acceptor then becomes liable for paying the bill. If the bill is sold in the money market it is said to be “discounted”. The seller receives the face value of the bill Less the interest at an agreed rate for the currency of the bill.
In addition to the three modes of foreign payments written above i.e:
(a) Bill of exchange,
(b) Banker’s draft, and
(c) Cable or telegraphic transfer; there are five other modes of payments in international trade, they are: (i) Payment in advance, (ii) Open account, (iii) Documentary bills, (iv) Documentary credit under letters of credit, (v) Shipment on consignment basis.
1. Advance Payment:
When the exporter receives the bank draft or bank advice before the contractual obligation of shipment is fulfilled. The payment may be received either as soon as the order is confirmed or any time before shipment. This method is most advantageous from exporter point of view. The exporter may be willing to impose the term as a pre-condition only when he knows that the goods are in heavy demand and the goods are of rare-nature.
2. Open Account:
Under this method the exporter sends the invoice and other documents relating to transfer of title and possession of goods direct to the buyer (importer) and on receipt of such documents the importer remits the amount involved immediately. In case a credit period is allowed the importer will make the payment at the expiry of the credit period. This method is very simple and avoids many complications and additional charges. The entire risk in this case is of exporter. In India, the Reserve Bank of India has permitted the facility for inter-company transactions against “Round Sum Remittances.”
3. Documentary Bills:
The above mentioned two forms of payment—advance payment and payment on open account are not very common in foreign trade. The documentary bills is a very common method adopted for payment in international trade.
These bills act as a bridge between:
(i) The unwillingness of the exporter to part with the goods until he is paid for, and
(ii) The unwillingness of the importer to pay for the import unless he is sure of receiving the goods.
Banks act as a via-media by giving the necessary assurance to both the parties. Under this form of payment, the exporter submits the documents to his bank along with the bill of exchange. The exporter’s bank then sends the bill along with the documents to its correspondent bank in the importer’s country and presents the bill before the importer either for payment or for acceptance as per terms of the bill. The documents along with bill are full set of bill of lading invoice and a marine insurance policy.
There are two types of documents under this method:
(i) Documents against Payments (D/P), and
(ii) Documents against Acceptance (D/A).
(i) Documents Against Payment (D/P):
In such cases goods are shipped and the documents of title of goods along with the bill of exchange are surrounded to his bank by the exporter. The bank will send the documents and bill to its correspondent bank in the importer’s country.
The bank in the importing country will present the documents along-with the bill to the buyer and on making the payments of the bill of exchange will hand over the documents to the importer. Until the payments are made the title to the goods vests with the exporter.
(ii) Documents against Acceptance (D/A):
In this case the documents are sent to the importer through banker, the banker presents the bill to the importer for acceptance and if he accepts the bill, the bank will deliver the documents of title to the buyer (importer) so that he may take possession of goods. On due date, the bank will again present the bill to the buyer for payment and if payment is received, the collecting banker sends the amount to the exporter through normal banking channels to be credited to his account.
Normally, under D/A bills the exporter will have to wait for payment till the final payment is received on due date. This may take time and the commercial banks very often discount such acceptances and thus the exporter receives the payment of the bill immediately after shipment of goods. Both the types of bill-D/A and D/P are common in export trade, there are various commercial risks which the exporter must take into account before he agrees to accept payment on such basis.
4. Documentary Credit under Letter of Credit:
This is the most popular form of the payment now-a-days. Under this system the banker of the importer undertakes the responsibility to pay the exporter, under instructions from the importer. If the exporter presents certain shipment and payment documents covering the goods within a specified period. In effect, the credit of the issuing bank is substituted for that of the buyer. Such written undertaking of the importer’s banker to the exporter is known as letter of credit or L/C.
5. Shipment on Consignment Basis:
Under this method the exporter makes shipment of goods to overseas consignee/agent without making any claim for payment for the goods shipped but retains the title of the goods with him as also the risk attached three to even though the possession of goods with the overseas importer. The payment under such contracts will be made only when goods are sold under contracts the risk is of great amount. Thus, the best form of international payment is the documentary credit against Letter of Credit and D/P or D/A come to next. All other methods are rarely adopted under terms of contract and under special circumstances.
Rate of Exchange:
Rate of exchange is that rate at which a unit of one country exchanges for the currency of another is the rate of exchange between them.
When the imports and exports of a country are equal the demand for foreign currency and its supply or conversely, the supply of home currency and the demand for it will be equal. The exchange will be at par. If the supply of foreign currency is greater than the demand it will fall below par and the home currency will appreciate.
Exchange Rate Determination:
Now, we are going to examine how the rate of exchange in determined under different monetary systems:
(i) Under Gold Standard:
When two trading countries both having gold standard, their currencies can be converted into gold at a fixed rate. The exchange rate between the two countries will not depart or fluctuate much from the Mint Par and will move between the two points of export and import of gold. These points are called “Gold Points” or “Specie Points”. This point is established by adding or subtracting the cost of transporting gold from the Mint Par.
(ii) Where one Country is on Gold Standard and the Other One is on Silver Standard:
Suppose there are two countries say Britain and India. Britain is having a gold standard and India the Silver Standard. How the rate of these two countries will be determined? The rate in India will depend on the price of gold in terms of silver. In the same way, in London, the rate of exchange will depend on the price of silver in terms of gold. This system also does not prevail anywhere.