Letter of Credit and Pre-Shipment Finance

Two arrangements deserve closer attention because they solve the two biggest worries in export trade: will I be paid? and how do I fund the goods before I am paid?

Letter of Credit (L/C). In export trade the buyer and seller are in different countries and often do not know one another well. The exporter is reluctant to ship valuable goods across the world on the mere promise of a distant buyer, and the importer is reluctant to pay before the goods are shipped. A Letter of Credit resolves this deadlock by bringing a bank into the middle. It is a written undertaking given by the importer's bank (the issuing bank), at the importer's request, that it will pay the exporter a stated sum provided the exporter presents the specified shipping documents within the stated time and in strict conformity with the terms of the credit. In effect, the exporter no longer relies on the buyer's creditworthiness but on a bank's undertaking, which is far more dependable. This is why the letter of credit is described as the standard and most secure method of payment in international trade, and why obtaining it is placed early in the export sequence — before the exporter commits money to producing and shipping the goods.

Pre-shipment (packing) finance. Between accepting the order and receiving payment, the exporter has to spend money — buying raw materials, manufacturing or procuring the goods, packing them and getting them to the port. This can be a long gap, and the exporter's own funds may not be enough. Banks therefore provide pre-shipment finance (also called packing credit): short-term working-capital finance granted against a confirmed export order or a letter of credit, specifically to enable the exporter to procure, manufacture, pack and ship the goods. The finance is later adjusted when the export proceeds are realised. Because it is tied to a genuine export order, such finance is usually available on favourable terms as part of the government's and RBI's policy of encouraging exports. …