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Risks Encountered by Corporates in
Cross Border Business

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Various Types of Risks Encountered by Corporate Units in Cross Border
Business & Methods of Managing such Risks

As part of the Liberalisation and globalisation of national economies, Governments in the process of trying to boost the export of goods and services, will try to encourage Corporate units to get involved in cross-border trade and cross border technology tie-ups. However the process of increasing cross border trade, cross border financing and cross border technology tie-ups will also imply that the cross border risks is an important element in any Corporate plan to go in for cross border markets.

  1. Delivery Risk
    Delivery risks refer to the uncertainties involved in procuring, manufacturing and delivering the goods to the buyer. This will result in defaults in effect deliveries as per schedule. Consequently Documentary L.Cs established by the buyer may expire before the goods could be shipped.

  2. Country Risk or Political risk
    Country risk refers to the possibility that the Government or the Central Banks of the buyer country. When goods are shipped they have to pass through International water implying potential risks of war and disturbances enroute. Custom regulations, quality control regulations, export/import procedures of the buyer or seller country may also delay delivery schedules

  3. Credit Risk
    Credit risk refers to the possibility that the Government or the Central Bank may not pay or may delay payments due to crisis of BOP.

  4. Currency Risk
    Currency risk or exchange risk refers to the threat as faced by the volatility or fluctuations in exchange rate. If the exchange rate between the buyer’s currency and the seller’s currency changes violently during the course of the transaction, one of the two parties will have to bear substantial losses.

  5. Interest Rate Risk
    Interest rate risks are due to floating interest rate system, which is prevalent in many of the developed countries. Floating interest rate means that the cost of borrowing changes constantly.

Managing of Cross Border Risks

Many of the perils, which are potential in export/import trade, can be avoided if prudently handled. Except the risk of exchange and currency fluctuations most of the other risks are classified as Commercial or Political risk. Exporters can cover these risks by opting for Insurance from Export Credit Guarantee Organizations, which protect both the exporters and the financing banks. The risks for an importer of these categories are comparatively less and the importer have avail maximum benefit from establishing Documentary Credits with suitable terms and conditions intended to ward off all conceivable risks. Opting for forward cover can cover currency and exchange risk. Trade and commerce are better established through person to person contacts. Regular Exporters and Importers will do well to visit at least once in a year their counterparts in their countries, which substantially builds mutual confidence. The exporters/importers may also avail the facility of collecting credit reports on their overseas counterparts through their Bankers.

A closed analysis of the list of threats faced will indicate that credit risk and delivery risk is common to internal transactions as well. However currency and interest rate risks are peculiar to cross-border business.

Delivery Risks

Buyers from sellers face the risk. Buyers can ensure that no advance payments is sent to the sellers blindly and purchases are normally covered under Letters of Credit established through first class Banks. Domestic exporters should counteract against their peril, by streamlining inventory management and proper planning material movement schedules proving a small margin ahead of the contracted schedule.

Credit risks

A safety net for this is the Mode of transactions through Letters of credit, which protect both the seller and buyer.

Interest Rate Risk

Where there is scope for this threat, it is advisable to go in for shorter-delivery schedules and consignments for ad-hoc sale and purchase instead of over-stretched despatch schedules extended over a long period. The assumption is that this threat does not unfold itself in the short-term, even if it occurs, its impact is within tolerance level.

Currency Risk Management

Risk management is met through both internal, and external hedging as under

Internal Methods

  1. Currency of Billing:
    In this method risk is eliminated by contracting the sale transactions in the home currency.

  2. Leading, Lagging and Matching:
    This is possible if the Corporate unit has a stream of exports & imports, resulting in both payment, as well as receipt of foreign currency. It is possible to match the export and import schedules to provide for matching funds-flow in either direction.

  3. Currency Hold Accounts:
    It is a method of opening a foreign currency account and depositing export earnings and other exchange receipts in the said account, to generate risk-free funds for payment of the imports.

  4. Lending and borrowing methods:
    In this method a Company which has to make a foreign exchange payment at a future date, and wishes to avoid a possible appreciation of exchange rate, can buy Dollars at the current spot rate and invest the money by lending or depositing in a foreign currency account, upto the date of payment, to be used at the time of payment.

External Methods

  1. Forward Contracts:
    Forward contracts are offered by Banks. In forward contracts Banks quote an exchange rated today for sale or purchase of foreign exchange at a future date.

  2. Futures Contract:
    Currency futures are exactly similar to forward contracts except that the deal is put through a futures exchange, which functions on lines similar to a stock exchange. These contracts are available for fixed amount and standard period, and thus do not command the same flexibility as forward contract

  3. Swaps:
    Swaps are long term hedging instruments to manage exchange rate and interest rate risks. It is possible when there are two parties interested in converting foreign currency in domestic currency and interested in covering the transaction over a long span of time. A major advantage of swap is that it allows tbat parties to hedge exchange rate fluctuations over a long period of time.

  4. Options
    Options, as an instrument is an improvement over forward and futures contracts. In a forward contract the Bank as well as the customer are under obligation to complete the transaction art the specified date irrespective of the exchange rate movement. In an option the bank has an obligation but the customer has a right and no obligation

Country Risk Monitoring
Definition and purpose of country risk monitoring

Cross border trading and cross border financing exposes the trader to several risks not normally faced in the domestic trade. These risks can be categorized according their nature and catalogued. In addition to normal commercial risk inherent in all business transaction, overseas trade exposes the trader to risks of political, currency and exchange rate fluctuations, not normally faced in domestic trade.

Country risk is one such category. Countries of the Globe operate under varying political and legal system, economic development and financial strength. Most of the currencies of the third world countries are not stable and subject to wide fluctuations in the international market. These countries always suffer an adverse balance of trade and balance of payments. They need huge imports of essential goods and capital equipment, while they are unable to boost their export trade on account of limitations posed by the under developed status of the economy. It is possible that the importer of goods in this country is a sound party and he makes payment to the Bank for the export bill in his native currency. But due to adverse balance of payments position continuously suffered by the country, it does not possess the foreign exchange and hence unable to remit the amount to the exporter. This in particular is an example of the country risk that may be faced by an exporter.

A country risk monitoring implies an assessment and rating of the various risks like political, economic or commercial threats inherent in dealing with overseas counterparts in a particular country. The risks emanate from the Country, due to political or economic conditions, or due to the Policy of its government or its Central Bank This assessment takes into consideration the recent past record of that country (say for the last 5 years) and then makes an intelligent projection of future anticipated trends. Such a study at the outset involves the selection of relevant parameters or criteria for identification of the risk perception. It is of particular relevance that the parameters selected should be prioritised and given weightage in terms of their relative importance, A relatively insignificant risk will naturally carry a low priority and an equally low weightage.

Categorizing and sub-categorizing Country risks.

Broadly the risks inherent in respect individual countries may be studied under categories.

  1. Economic or Commercial Factors

  2. Political factors

Whether the country is having a sound economy And economic solvency to perform its financial obligations? Is there political turmoil in the country and in case there is a dispute with the importer of the country, whether the country’s legal system provides safeguards for quick remedies?

These are the two factors that come in the way of deciding the country’s record. Economic factors reflect the country’s inherent strength or weakness. There are countries with stable economies, as also country suffering from acute balance of payment problems. The political system prevailing in a country shapes its external policy. There are dictatorships, theocratic states, monarchies and democracies, each based on different legal systems and political culture and ethics.

Parameters for assessment of Economic Risks:

  1. Debt Service Ratio:
    This refers to relevant data relating to the amount needed to service the external debt (i.e. annual payment of interest and principal on external borrowings), as compared to the country’s earnings from export of goods and services. This indicates the capacity of the country to pay. And the balance of payment solvency. Many under developed countries depend on fresh external loans for repayment of previous loans. A higher weightage can be given to this criteria and

  2. Debt-GNP Ratio:
    Debt-GNP ratio represents the external debt as a percentage of GDP. This indicates the extent of debt as a ratio of GDP.A high Debt-TGDP Ratio in excess of 40% indicates long-term financial problems for the country.

  3. Debt-Maturity:
    This concepts highlights the maturity-wise table of the existing debt burden and focuses the short term debt burden accruing in the next 2 to 3 years. A higher incidence of short-term debts indicates a more likely possibility of default in the immediate future. On the other hand if major part of the loan is long-term, the country has more time to plan and set its house in order.

  4. Current Account Deficit to GNP Ratio:
    The current account deficit (except for transfer payments) represents the excess of expenditure over income for the country. A deficit of 5% is deemed a fairly difficult situation, while that of 7.5% indicates deep-seated weakness.

  5. GNP Per capita:
    The GNP per capita indicates how rich and developed is the country. A high GNP enables the country to take adequate steps for improving its earnings and overcome problems of default and rescheduling.

  6. Inflation Rate:
    Inflation rate above 5% is a serious threat, while double-digit inflation represents a state beyond control. In developed countries inflation is controlled and this provide them a stable price /cost structure.

  7. Savings Ratio:
    A high Savings rate indicates higher mobilization internally of capital and thus reducing reliance on external borrowings. A higher savings rate usually indicates better ability of the Government to manage and therefore less country risk.

Parameters for Assessment of Political risks

  1. Internal Stability:
    A stable government is able to undertake long term planning and execute Development plans on a continuous basis. It automatically increases external ratings of the country.

  2. External Stability:
    The country that promotes good relations with its neighbours and with other whom, it has interactions, is better placed to promoter its foreign trade and attracts foreign investment,

  3. Other factors like legal system:
    The location of the country, its educational and cultural systems and legal systems for enforcement of remedies in case of disputes in trade transactions are other criteria.


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