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Dhaka Tribune

OP-ED: Export trade: A peculiar equation

What needs to be done to keep exporters and banks in Bangladesh safe from defaulting

Update : 25 Jan 2021, 02:45 AM

Experts have been talking about export diversification in Bangladesh for a long time. In support of their propositions they have advocated for bilateral free trade agreements, new market explorations, etc. However, export is still mostly confined to RMG, which covers more than 85%.

During the late 80s, RMG started moving forward with the support of a South Korean corporate house and the patronization of the government. Think tanks, academics, and economists are all interested in this sector, but educated people are not interested in working in export sectors as employees.

Imports and exports are international trades. Payment against import and export is of different types -- payment in advance, letters of credit (LCs), documentary collection, and open account.

In case of payment in advance, exporters remain safe from payment defaults by importers, since payment is received prior to the transfer of ownership of shipments. Transactions under advance payment are very rare in Bangladesh.

Under the LC method, payment is settled by its issuing banks against compliant documents. It is said to be the most secure method available for international trade. In Bangladesh, most imports are executed under LC methods. With regards to exports, sales contracts are used with credit facilities. Exporters do not have any safeguards in case of payment defaults by importers under sales contracts. On the other hand, this contract system lets importers avoid LC costs.

Documents are sent abroad for collection of payments and are of two types -- documents against payment (DP) and documents against acceptance (DA). In case of DP, documents are released on receipt of payments. But shipping documents are released on acceptance by importers. Banks abroad are not responsible in case of default by importers; they just intimate the situation to exporters’ banks.

Under the open account method, goods are shipped on credit terms with payment commitments from banks/financial institutions abroad. Exporters need to bear payment guarantee costs. Very recently, the central bank allowed export on open accounts with external payment commitments, including early payment facilities from external sources.

Export trade in Bangladesh depends on consumer goods. Our exports go to rich countries, but rich buyers want credit facilities. Export on credit should be done via the LC method, but our exporters are forced to export under paper contracts. In a recent discussion by an international trade body, Bangladesh was found to be a leading country in issuing import LCs.

There are around 20 items required for the production of RMG goods, most of which are procured through LCs. This is executed from suppliers in East Asia, nominated by foreign buyers. Though exports are under contracts, nominated suppliers do not provide goods under the same contract arrangements. They are given LCs known as back-to-back LCs.

Under de jure, back-to-back LCs are permissible under export LCs as per regulatory frameworks. But paper contracts are available with exporters instead of LCs. Banks open back-to-back LCs on the basis of LC limits approved to concerned exporters. Despite the deviation from regulations, there is no alternative.

The world trading system has been affected by Covid-19. Export trade in Bangladesh has been under threat. Huge export orders are reported to have been cancelled. But why? Have importing countries declared force majeure? This has not happened.

This has been caused by peculiar equations -- export under paper contracts and input procurements under back-to-back LCs. Due to the pandemic, shipments remain unreleased at ports and orders of produced goods become cancelled. Interestingly, exporters are obligated to make back-to-back payments though they are out of export proceeds in hand.

Banks have settled back-to-back payments by creating forced loans favouring exporters. In this situation, LC experts of the country advocated for electronic presentation of import documents. But no suggestions have been found regarding the non-realization of export proceeds by exporters. In reality, enforceability of paper contracts for realization of payment is very long and not exporter-friendly.

No safeguards are available in case of non-payment by importers. Many exporters become defaulters, and later opt for export under paper contracts with importers in neighbouring countries. The poor selling goods to the rich on credit terms is a ridiculous equation, indeed.

Back-to-backs cannot run alone. They are connected to export orders, but are partial since back-to-back LCs are issued against paper contracts without export LCs. Import procurements should be executed through back-to-back contracts. 

Input imports can be imported by sales contracts without LCs and, as such, are desirable. But we are in the buyers’ market while on export and in the sellers’ market while on import. Importing countries face no negative impact on their credit ratings despite non-payments. But the opposite picture is found in case of our import payments.

Retired officials of the RMG sector have discussed that back-to-back LCs were once settled out of export proceeds, for which the realization clause was incorporated in LCs. This arrangement is still available for industries operating in specialized zones. Recently, the central bank allowed the clause in back-to-back LCs for industries operating in domestic tariff areas, provided that suppliers agree.

Suppliers abroad do not accept LCs with a realization clause, which results in bank payments despite the unavailability of export proceeds. Non-receipt of export proceeds causes exporters to run out of business. Recently, the central bank introduced a policy under which export is permitted on open account credit terms against payment guarantees from foreign banks, financial institutions, and insurance companies. Under it, exporters will have to make themselves safe by purchasing payment guarantees at their own costs. This will make exporters safe, but it may be costly for them.

Requirements need to be set for input procurements by back-to-back contracts against exports under sales contracts. Alternatively, opening back-to-back LCs with a realization clause in case of exports against sales contracts should be made mandatory. This will keep exporters safe, and banks will also be in safe territory.

Mehdi Rahman works in an export-oriented industry.

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