What is International Trade Finance?

International trade or foreign trade is based on the theory of comparative cost advantage. Since each country has certain benefits from production of a particular product or commodity, they use their resources which are exclusively available in that country. Thus if the crude oil is exclusively available in oil producing countries, they have a comparative advantage of crude oil production at a cheaper rate over other nations. Thus exporting to oil deprived nations will earn it profits. Thus no country is self-sufficient and depends on other nations for some product or service. International trade thus encourages the theory of comparative cost advantage so that whatever product is produced cheaper than other economies is exported to make profits.

The Trade Financial Transaction takes place when an exporter and importer agree to a contract. Wherein the exporter requires an importer to prepay for the goods shipped. The letter of undertaking (LoU) or letter of credit (LC) serves the purpose and works as a documentary proof of the shipment details. The  letter of credit is issued by the importer’s bank to the exporter’s bank providing for the payment upon presentation of bill of lading. The banks deal with documents and not the physical goods or services.

The balance of payment is a periodic statement of money value of all transactions between residents and government of one country and residents and governments of all other countries. They are usually categorized into three accounts: the current account (export and import), the capital account (purchase of assets by foreigners and foreign assets purchased by residents), and official reserve account (holding of foreign currencies and currency held by foreign governments).

The current account is the difference between the value of goods exported and the value of goods imported. Exports are products that a country sells to other countries and imports are products that a country buys from other countries. A country will have a trade surplus if its exports exceed imports. On the other hand, a country will have a trade deficit if its imports exceed its exports. India currently has a trade deficit.

International trade & finance form an important part of any economy and the international finance derives its value from the international trade.

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