One of the ever-present problems in international business is the extension of credit. Whenever international business people assemble and the subject turns to trade conditions in particular countries, the question inevitably raised is: “What terms do you grant?” The differences in the terms are often due to the products for which the terms are cited. There is also difference in the way marketers appraise a particular market. Therefore, it would appear that the appraisal of the credit situation of a buyer in a particular market is determined by a number of factors. Before looking at these factors, however, it would be well to examine closely the meaning of foreign credit.
The Meaning of Foreign Credit
Credit usually refers to the procedure of surrendering title to merchandise without immediate payment. In other words, credit means trusting the buyer to pay for goods after title to them has been obtained by the buyer. Under the various credit and payment terms described earlier, a buyer would receive credit under open account and under all draft transactions. Under a letter of credit, the exporter (beneficiary) is assured of payment; therefore there is no credit risk.
There is another aspect of credit, however, that should also he considered. That is the credit needs of the firm which is engaged in exporting merchandise, because there is a period of time elapsing between the shipment of the order and the time that payment is received. A payee of a draft may discount or borrow against the draft before its maturity but in doing so, interest for the period of time for which the funds are advanced must be paid. Moreover, there is no assurance that the draft will eventually paid by the drawee.
The inference may easily be drawn that under all credit and payment terms except open account, a payee (exporter) can make use of valuable documents to obtain immediate finances, if such finances are required. However, banks will not discount or loan against accepted drafts beyond a certain limit set by the line of credit that the bank has set up for each individual customer. The line of credit establishes a maximum amount that will be loaned to a customer. A limit may be placed on the rupee value of discounting or borrowing that an exporter will be permitted to receive.
Conditions Influencing Foreign Credit Extension
There are several conditions peculiar to international marketing that require an exporting firm to view foreign credit differently from domestic credit. These conditions are:
- Supply of banking capital: Importers located in underdeveloped areas have depended upon foreign sellers to finance their purchases of consumer goods, transportation, automobiles, or infrastructure improvements because local bankers were unable to provide the financing. The supply of capital is quite meager in these countries.
- Interest rates: Interest rates in non-industrial areas may be substantially higher than in industrial countries. In such circumstances, the wisdom of an importer borrowing abroad at relatively low interest rates and lending the funds at home becomes apparent.
- Diversification of production: The lack of developed business system is another factor entering into the foreign credit situation. In underdeveloped or developing areas of the world, intensive specialization in commodity or functional lines may not be warranted, and the business person may frequently combine several types of business ventures in order to earn an adequate income. This imposes a heavy financial responsibility. Another factor accentuating this condition is the lack of diversified production. Many countries have only certain primary products for export such as sugar, rubber, coffee, etc. It is quite conceivable that a crop failure or a low price could cause an economic collapse. If this occurs, not only the growers, but also businesses, bankers, and others may be placed in precarious positions.
- Time in transit and business turnover: Because of the length of time elapsing between the date of shipment by the exporter and the time when goods are received by the importer, there may be a considerable period during which, in the case of cash payment, the importer is without both – funds and goods. If credit of sufficient duration is granted to enable the importer to obtain the goods before making payment, the exporter bears the financial burden of the import transaction, but the sluggishness of turnover may leave the goods in the hands of the buyer for a considerable additional period of time, during which the buyer’s funds would also be tied up. This condition is of little significance in domestic trade where shipments may be made quickly, but in international trade it presents an important problem. It may be weeks or months before the importer located at an inland destination receives the merchan dise. Moreover, customs duties and transportation charges may be paid before delivery. In addition, distance and time compel importers to place orders for substantial quantities of goods long before the selling season opens
- Exchange rate fluctuations: Still another condition influencing credit extension in international trade is the fluctuation in foreign exchange rates. Whenever a buyer receives quotations and accepts prices in a currency other than the native currency, the buyer assumes a speculative risk against which protection may or may not be obtained. If the buyer has agreed to pay for the purchases by sight draft, utmost the that payment can be postponed and possession of the goods received is upon their arrival. An exchange loss sufficiently great to eliminate the anticipated trade profit may be incurred.
- Competition: Credit may also be extended for competitive reason. As a means of promoting sales, liberal credit terms may be offered. Moreover, it may be difficult for an exporter to refuse credit terms at least as liberal as those granted by rival suppliers.
- Customs: Credit extension is influenced by the credit customs of the foreign market. Certain terms are often established in each market along commod ity lines, and they are to be recognized by exporters selling in those markets.
At the outset, it is well to emphasize that the influence of these conditions varies from country to country. While in Canada foreign credit conditions are practically identical with those in the United States, except for foreign exchange rates and tariffs, the conditions influencing foreign credit extension are different in Mexico. The supply of capital varies greatly among countries and is highly dependent on the nation’s natural resources and past production.