Pre-shipment Trade Finance- How is it Beneficial for Corporate?

Pre-shipment Trade Finance- How is it Beneficial for Corporate?

20 Aug 2019 03:10 PM
 

All businesses require finance to support activities. It is here that trade finance works as the lifeblood of cross-border transactions. It helps them in keeping the flow of working capital in tune. Talking about export trade finance, it can be availed in the pre-shipment and the post-shipment stage by Corporate in international trade business.

Pre-shipment trade finance is a credit solution that enables exporters to avail credit finance before the shipment of goods. It is offered by banks on a “with recourse basis” generally against either a confirmed export order from the buyer or against a Letter of Credit. Once the packing credit is sanctioned, exporters can channelize this amount to purchase- goods, raw materials for subsequent manufacturing of final goods, warehousing and the transportation of goods.

After shipping the goods, exporters can opt for Post-Shipment Credit to advance the payment. This helps them override liquidity crunch between the shipment of goods and receipt of the payment. In case of post-shipment credit, the following products are available for managing working capital needs-

  1. Invoice factoring or receivable discounting (by selling receivables document or invoice bills)
  2. Letter of Credit Bill Discounting or
  3. Trade loan via an accounts receivables document

Modes of Pre-shipment Finance

Pre-shipment packing credit can be extended in two forms:-

1) Packing Credit in Indian Rupee (PCINR). This is also known as Export Packing Credit (EPC)

2) Packing Credit in Foreign Currency (PCFC)

Apart from the difference in the currency of the pre-shipment credit, there is large difference in interest rate between the two modes. PCFC is usually granted in the currency of exports (which are generally low interest rate currencies such as USD/EURO/JPY). In PCFC, foreign currency loan is disbursed upfront in preference of future export receivable in foreign currency. Therefore, the export receivables cannot be hedged. PCINR on the other hand is denominated at higher interest rate (given that INR interest rates are higher) but the future receivable is still due in foreign currency. This allows exporters to retain the option of hedging and receiving premium on exports in the case of PCINR.

In other words, the difference in the rates between these two modes is predominantly accounted by a difference in interest rates in the two currencies which manifest itself to some extent in the exchange premium. It is usually seen that PCFC is more cost effective than PCINR on an apple-to-apple comparison basis.

  Interest Rate & Maturity Period

Banks extend Pre-shipment Credit in Foreign Currency (PCFC) to the exporters linked to the London Interbank Offered Rate (LIBOR). In case of PCINR, the credit is priced against the MCLR rates of the banks.

In the case of PCFC, Export companies get the freedom to avail Pre-shipment finance in convertible currencies like USD, Pound, Sterling, Euro, YEN, etc. However, in case the currency of the financing is different from the currency of the exports, then the exporter is exposed to one leg of the foreign exchange risk. In case of PCINR, exporters are subject to risks associated with forex fluctuations as credit is disbursed in INR and receivables are in FCY. The forward premium is the interest rate differential between two country’s risk free rate of interest.

Pre-shipment Finance is provided on a program basis, covering a series of transactions (typically for smaller sellers) or on a transactional basis (typically for larger sellers). The finance provider is likely to advance a certain percentage of the value of the order, potentially disbursed in stages as the order is fulfilled.

Maturity dates for the financing are established between the seller and finance provider and this is often tied to the ultimate date on which the buyer will make payment. The overall tenor of pre-shipment credit is generally the time taken from receipt of export order to cash realisation a.k.a. the working capital cycle.

Benefits of Pre-Shipment Credit

  1. Exporters receive funds in advance, that they can use to fund working capital needs
  2. Exporters have either an Export Order or a Letter of Credit to support the customer’s application so this makes the cost of financing invariably cheaper than an overdraft.
  3. With the lower cost of financing, exporter competitiveness is improved.
  4. The credit facility helps exporters to easily plan out their expenses and income in local currency (INR) by using PCFC as a potential instrument towards hedging currency risks. This advantage is however applicable when credit is provided in foreign currency.

Experienced Guidance

Myforexeye’s Trade Finance services can help exporters

  1. In providing guidance on prevailing trade-offs between borrowing in FCY v/s INR
  2. Work out strategies of using hedging as a tool coupled with pre-shipment credit.

Clients may also avail expert guidance for Risk Advisory Service related to foreign currency movements, including forward premiums and risk mitigation strategies.