Methods of International Payment in International Trade: Indian Context

 

In the context of international trade, getting paid in full and on time is crucial for exporters to succeed. The chosen payment method must balance the needs of the exporter to minimize risk and the buyer's preference to delay payment until they receive the goods. There are five primary methods of payment in international trade, each differing in terms of risk for both the exporter and importer. Here’s a detailed explanation of the methods used, considering India's global trade practices:

1. Cash-in-Advance

Meaning:
In the cash-in-advance method, the buyer makes the payment before the goods are shipped. This is the safest method for the exporter because it eliminates credit risk.

Indian Example:
An Indian exporter of gemstones may use this method when trading with a new customer in an unfamiliar market to ensure that payment is secured before sending high-value goods.

Advantages:

• Eliminates risk for the exporter.
• Ensures immediate payment.

Disadvantages:

• Risky for the importer, as the buyer must pay without having received the goods.
• Not competitive for exporters, as buyers may prefer sellers who offer more favorable terms.

Common Methods in India:

• Wire Transfers: Common for high-value transactions.
• Credit Cards: Suitable for smaller transactions, especially in e-commerce.

2. Letters of Credit (LC)

Meaning:
A Letter of Credit is a financial instrument issued by the buyer's bank guaranteeing that the exporter will receive payment as long as certain conditions are met, typically involving the delivery of specific documents like the Bill of Lading.

Indian Example:
An Indian textile manufacturer exporting to European buyers may use an LC to ensure secure payment, particularly when dealing with large orders and unfamiliar customers.

Advantages:

• Reduces risk for both parties since the bank guarantees payment.
• Ensures that the buyer will only pay after receiving proper documentation.

Disadvantages:

• High bank fees associated with processing LCs.
• Complex and time-consuming documentation process.

Types of LCs in India:

• Irrevocable LC: Common in India’s export market, it cannot be changed without both parties’ consent.
• Confirmed LC: Especially useful when the importer’s country is considered politically or economically unstable.

3. Documentary Collections (D/C)

Meaning:
In this method, the exporter’s bank collects the payment from the importer’s bank in exchange for the shipping documents. This can be done with Documents Against Payment (D/P), where payment is made on sight, or Documents Against Acceptance (D/A), where payment is made at a later date.

Indian Example:
An Indian spices exporter might use D/C for established customers in markets like the Middle East, where trust is higher, and full security is not as necessary as in new markets.

Advantages:

• Lower cost compared to LCs.
• Offers a moderate level of protection to the exporter.

Disadvantages:

• The exporter is at risk if the importer refuses to pay after receiving the documents.
• No guarantees or verification from the banks, so it involves more risk than LCs.

4. Open Account

Meaning:
Under this method, the goods are shipped and delivered before payment is due, typically within 30, 60, or 90 days. It is highly favorable to the importer, as they receive the goods and have time to sell them before making payment.

Indian Example:
Indian IT service companies offering software services to U.S. clients may use the open account method, relying on the strong relationship and trust built over time.

Advantages:

• Attractive to buyers, improving competitiveness.
• Increases the chances of securing contracts in competitive markets.

Disadvantages:

• High risk for the exporter, as payment is not guaranteed.
• Delayed payment can affect the exporter’s cash flow.

Risk Mitigation:

• Export Credit Insurance: Indian exporters may use insurance to protect against non-payment.
• Factoring Services: Selling receivables to a third party to secure immediate payment.

5. Consignment

Meaning:
In consignment, the exporter ships goods to a foreign distributor or agent but retains ownership until the goods are sold to the end customer. Payment is only made after the goods are sold, which involves a high level of trust.

Indian Example:
An Indian agricultural exporter sending perishable goods like fruits to international markets (such as Gulf countries) might use consignment to ensure timely delivery and reduce storage costs abroad.

Advantages:

• Helps exporters reduce the costs of storing goods and improves delivery speed.
• Enhances competitiveness by offering more flexible payment terms.

Disadvantages:

• High risk for the exporter, as payment is only made if the goods are sold.
• Goods may remain unsold or be damaged, leading to potential losses.

Risk Mitigation:

• Use of a trusted foreign distributor or third-party logistics provider.
• Insurance to cover goods in transit or while held by the distributor.

Payment Risk Diagram

In international trade, different payment methods offer varying degrees of risk to both the exporter and the importer:

• Highest risk for the exporter: Open Account, Consignment.
• Lowest risk for the exporter: Cash-in-Advance, Letters of Credit.
• Highest risk for the importer: Cash-in-Advance.
• Lowest risk for the importer: Open Account, Consignment.

In international trade, selecting the appropriate payment method is critical for reducing risk and ensuring smooth transactions. For Indian exporters, methods such as Letters of Credit (LC) and Documentary Collections (D/C) are commonly used due to their balance of security and flexibility. Open Account and Consignment are high-risk methods but can be employed with trusted business partners or with the use of risk mitigation strategies such as credit insurance. Ultimately, the choice of payment method depends on the relationship between the exporter and importer, the market conditions, and the nature of the goods being traded