Trade, import and export for MSMEs: Ensuring timely payment, avoiding discrepancies in export contracts, tackling foreign exchange volatility, etc., are some key financial risks for a small or first-time exporter to look at in detail.

Trade, import and export for MSMEs: In order to accelerate India’s economic growth fuelled by its exports, which are targeted by the government to hit the $750-billion mark this fiscal, the trade potential of the MSME sector must be maximised. To unleash this MSME-led export growth, understanding and mitigating risks involved in exports are as critical as having policies and schemes by the government to promote exports. Other than political or legal risks associated with a particular market along with challenges related to shipping or cargo, intellectual property, and ethics; financial risks are relatively more important to understand as they are at the core of a growing export business.

Ensuring timely payment, avoiding discrepancies in export contracts, tackling foreign exchange volatility, etc., are some key financial risks for a small or first-time exporter to look at in detail. According to Ashok Saigal, managing director of Frontier Technologies, which exports heat shrink items, and is also the co-chairman of the CII National MSME Council, the biggest risk for an exporter is a lack of certainty in receiving payments from the buyer.

“The first risk to be considered while dealing with buyers and countries with whom we don’t have day-to-day dealing or close understanding is how reliable that buyer is and the certainty of him paying for the goods,” he said in a panel discussion on exports at the recently held SMExports Summit 2023 organised by Financial Express Digital.

While a letter of credit or LC – a contractual bank document issued by the importer’s bank to assure the exporter of payment by the importer on receipt of goods – does help in mitigating the credit risk involved in international trade, by no means it fully guarantees payment to the exporter.

Saigal explained, “It is highly likely that a promoter would not be familiar with every nuance in the LC. You will misread one full stop or a comma or a particular phase and your letter of credit application will not be accepted by the bank. You will be at the mercy of the buyer whether he accepts those discrepancies or not.”

“In my experience, it was rare to find an instance, particularly when the customer was new in a new location, that there was no discrepancy. Hence, MSMEs must first know their customer thoroughly, how they work in business, and establish a relationship with them while you go through the LC for every order in detail otherwise an LC is only good enough for litigation purpose if you don’t get paid,” he added.

In other words, establishing mutual trust with the buyer may also help in ascertaining the probability of getting payment for goods in case of a discrepancy. In fact, it may help MSMEs to discuss the LC with their bank before accepting it.

“Particularly if there is a new buyer and new location, MSMEs should talk to their bank at the time of receiving the LC for the bank’s trade expertise. A bank can suggest which clauses an exporter should accept or ask for amendment as there might be certain clauses the exporter won’t be able to fulfil or understand,” said Kapil Bhatia, EVP and Head, Commercial Banking, Federal Bank during the panel discussion.

There are generally around 12 types of LC involved in international trade viz., revocable LC (cancelled or amended by the issuing bank at any time and without prior notice to or consent of the beneficiary), irrevocable LC, revolving LC (amount is renewed), transferable LC (transferred to one or more second beneficiaries), back to back LC, red clause LC (for the beneficiary to avail of an advance before shipment to the extent stated in the LC), green clause LC (provides advance for raw materials, warehousing etc), payment LC, deferred payment LC, etc.

When it comes to exports, foreign exchange is inevitable. Fluctuations in foreign currencies have been a perpetual issue for businesses in international trade and MSMEs, due to their size and scope, remain more vulnerable to the impact of forex volatility.

Also read: Explained: What makes for a great export market for first-time exporters

Anand Tandon, Founder and CEO of forex trading company Myforexeye Fintech explained what MSMEs should monitor while dealing in currency markets. According to Tandon, MSMEs should keep a hawk-eye on the exchange rate the foreign currency is converted when they receive it.

“There might be some slippages at the time as to what exchange rate is being applied to the currency you are receiving in your bank. This is something that can you give you instance profitability if you are able to curb that slippage,” said Tandon. Notably, forex hedging is a standard tool to avoid any loss from changes in exchange rates by pre-fixing the rate for a future transaction instead of using the rate prevailing at the time of the transaction.

Another area for MSMEs to look at is financing. With foreign exchange per se being coupled with borrowing, MSME exporters should be careful in choosing their financing options while executing orders between a domestic currency loan or a foreign currency loan called Packing Credit Loan in Foreign Currency (PCFC) to bring down their cost of borrowing, said Tandon.

PCFC is a pre-shipment loan to exporters by banks in foreign currency wherein the repayment by the exporter is also in the same foreign currency. It helps exporters with credit available at globally competitive rates. In comparison, export packing credit or EPC is a loan in domestic currency.

While in the case of a domestic loan, the net interest rate could be around 6 per cent — after getting around 3 per cent of interest subvention on around 9 per cent actual borrowing cost — the rate could be similar at around 6-7 per cent in PCFC, added Tandon.

Hence, MSMEs must evaluate the options. Nonetheless, in PCFC, the exporter repays the loan when he receives his remittance from abroad while in domestic credit, he settles the credit by converting foreign currency received into rupee and selling the foreign currency in the forward market later, said Tandon. “Now rupee being a high-interest cost currency means you receive a premium ranging from 2-5 per cent depending on the foreign currency you are selling. You lose this if you avail PCFC.”

https://www.financialexpress.com/industry/sme/msme-exim-in-depth-financial-risks-first-time-exporters-must-gauge-before-entering-international-trade/3003932/