ECGC

In order to provide export credit and insurance support to Indian exporters, the GOI set up the Export
Risks Insurance Corporation (ERIC) in July, 1957. It was transformed into export credit guarantee
corporation limited (ECGC) in 1964. Since 1983, it is now known as ECGC of India Ltd.
ECGC is a company wholly owned by the Government of India. It functions under the administrative
control of the Ministry of Commerce and is managed by a Board of Directors representing government,
Banking, Insurance, Trade and Industry. The ECGC with its headquarters in Bombay and several regional
offices is the only institution providing insurance cover to Indian exporters against the risk of non-
realization of export payments due to occurrence of the commercial and political risks involved in exports
on credit terms and by offering guarantees to commercial banks against losses that the bank may suffer
in granting advances to exports, in connection with their export transactions.
OBJECTIVES OF ECGC:
 To protect the exporters against credit risks, i.e. non-repayment by buyers
 To protect the banks against losses due to non-repayment of loans by exporters
COVERS ISSUED BY ECGC:
The covers issued by ECGC can be divided broadly into four groups:
1. STANDARD POLICIES – issued to exporters to protect then against payment risks involved in
exports on short-term credit.
2. SPECIFIC POLICIES – designed to protect Indian firms against payment risk involved in (i)
exports on deferred terms of payment (ii) service rendered to foreign parties, and (iii) construction works
and turnkey projects undertaken abroad.
3. FINANCIAL GUARANTEES – issued to banks in India to protect them from risk of loss involved
in their extending financial support to exporters at pre-shipment and post-shipment stages; and
4. SPECIAL SCHEMES such as Transfer Guarantee meant to protect banks which add
confirmation to letters of credit opened by foreign banks, Insurance cover for Buyer’s credit, etc.
(A) STANDARD POLICIES:
ECGC has designed 4 types of standard policies to provide cover for shipments made on short term
credit:
1. Shipments (comprehensive risks) Policy – to cover both political and commercial risks from the
date of shipment
2. Shipments (political risks) Policy – to cover only political risks from the date of shipment
3. Contracts (comprehensive risks) Policy – to cover both commercial and political risk from the date
of contract
4. Contracts (Political risks) Policy – to cover only political risks from the date of contract
RISKS COVERED UNDER THE STANDARD POLICIES:
1. Commercial Risks
 Insolvency of the buyer
 Buyer’s protracted default to pay for goods accepted by him
 Buyer’s failure to accept goods subject to certain conditions
2. Political risks
 Imposition of restrictions on remittances by the government in the buyer’s country or any
government action which may block or delay payment to exporter.
 War, revolution or civil disturbances in the buyer’s country. Cancellation of a valid import license
or new import licensing restrictions in the buyer’s country after the date of shipment or contract, as
applicable.
 Cancellation of export license or imposition of new export licensing restrictions in India after the
date of contract (under contract policy).
 Payment of additional handling, transport or insurance charges occasioned by interruption or
diversion of voyage that cannot be recovered from the buyer.
 Any other cause of loss occurring outside India, not normally insured by commercial insurers and
beyond the control of the exporter and / or buyer.
RISKS NOT COVERED UNDER STANDARD POLICIES:
The losses due to the following risks are not covered:
1. Commercial disputes including quality disputes raised by the buyer, unless the exporter obtains a
decree from a competent court of law in the buyer’s country in his favour, unless the exporter obtains a
decree from a competent court of law in the buyers’ country in his favour
2. Causes inherent in the nature of the goods.
3. Buyer’s failure to obtain import or exchange authorization from authorities in his county
4. Insolvency or default of any agent of the exporter or of the collecting bank.
5. loss or damage to goods which can be covered by commerci8al insurers
6. Exchange fluctuation
7. Discrepancy in documents.
(B). SPECIFIC POLICIES
The standard policy is a whole turnover policy designed to provide a continuing insurance for the regular
flow of exporter’s shipment of raw materials, consumable durable for which credit period does not
normally exceed 180 days.
Contracts for export of capital goods or turnkey projects or construction works or rendering services
abroad are not of a repetitive nature. Such transactions are, therefore, insured by ECGC on a case-to-
case basis under specific policies.
Specific policies are issued in respect of Supply Contracts (on deferred payment terms), Services Abroad
and Construction Work Abroad.
1) Specific policy for Supply Contracts:
Specific policy for Supply contracts is issued in case of export of Capital goods sold on deferred credit. It
can be of any of the four forms:
 Specific Shipments (Comprehensive Risks) Policy to cover both commercial and political risks
at the Post-shipment stage.
 Specific Shipments (Political Risks) Policy to cover only political risks after shipment stage.
 Specific Contracts (Comprehensive Risks) Policy to cover political and commercial risks after
contract date.
 Specific Contracts (Political Risks) Policy to cover only political risks after contract date.
2) Service policy:
Indian firms provide a wide range of services like technical or professional services, hiring or leasing to
foreign parties (private or government). Where Indian firms render such services they would be exposed
to payment risks similar to those involved in export of goods. Such risks are covered by ECGC under this
policy.
If the service contract is with overseas government, then Specific Services (political risks) Policy can be
obtained and if the services contract is with overseas private parties then specific services
(comprehensive risks) policy can be obtained, especially those contracts not supported by bank
guarantees.
Normally, cover is issued on case-to-case basis. The policy covers 90%of the loss suffered.
3) Construction Works Policy:
This policy covers civil construction jobs as well as turnkey projects involving supplies and services. This
policy covers construction contracts both with private and foreign government.
This policy covers 85% of loss suffered on account of contracts with government agencies and 75% of
loss suffered on account of construction contracts with private parties.
(C). FINANCIAL GUARANTEES
Exporters require adequate financial support from banks to carry out their export contracts. ECGC backs
the lending programmes of banks by issuing financial guarantees. The guarantees protect the banks from
losses on account of their lending to exporters. Six guarantees have been evolved for this purpose:-
(i). Packing Credit Guarantee
(ii). Export Production Finance Guarantee
(iii). Export Finance Guarantee
(iv). Post Shipment Export Credit Guarantee
(v). Export Performance Guarantee
(vi). Export Finance (Overseas Lending) Guarantee.
These guarantees give protection to banks against losses due to non-payment by exporters on account of
their insolvency or default. The ECGC charges a premium for its services that may vary from 5 paise to
7.5 paise per month for Rs. 100/-. The premium charged depends upon the type of guarantee and it is
subject to change, if ECGC so desires.
(i) Packing Credit Guarantee: Any loan given to exporter for the manufacture, processing, purchasing or
packing of goods meant for export against a firm order of L/C qualifies for this guarantee.
Pre-shipment advances given by banks to firms who enters contracts for export of services or for
construction works abroad to meet preliminary expenses are also eligible for cover under this guarantee.
ECGC pays two thirds of the loss.
 (ii) Export Production Finance Guarantee: this is guarantee enables banks to provide finance at pre-
shipment stage to the full extent of the of the domestic cost of production and subject to certain
guidelines.
The guarantee under this scheme covers some specified products such a textiles, woolen carpets, ready-
made garments, etc and the loss covered is two third.
(iii) Export Finance Guarantee: this guarantee over post-shipment advances granted by banks to
exporters against export incentives receivable such as DBK. In case, the exporter
Does not repay the loan, then the banks suffer loss? The loss insured is up to three fourths or 75%.
(iv) Post-Shipment Export Credit Guarantee: post shipment finance given to exporters by the banks
purchase or discounting of export bills qualifies for this guarantee. Before extending such guarantee, the
ECGC makes sure that the exporter has obtained Shipment or Contract Risk Policy. The loss covered
under this guarantee is 75%.
(v) Export Performance Guarantee: exporters are often called upon to execute bid bonds supported by
a bank guarantee and it the contract is secured by the exporter than he has to furnish a bank guarantee
to foreign parties to ensure due performance or against advance payment or in lieu of or retention money.
An export proposition may be frustrated if the exporter’s bank is unwilling to issue the guarantee.
This guarantee protects the bank against 75% of the losses that it may suffer on account of guarantee
given by it on behalf of exporters.
(vi) Export Finance (Overseas Lending) Guarantee: if a bank financing overseas projects provides a
foreign currency loan to the contractor, it can protect itself from risk of non-payment by the con tractor by
obtaining this guarantee. The loss covered under this policy is to extent of three fourths (75%).
(D) SPECIAL SCHEMES
A part from providing policies (Standards and Specific) and guarantees, ECGC provides special schemes.
These schemes are provided o the banks and to the exporters. The schemes are:
1. Transfer Guarantee: the transfer guarantee is provided to safeguard banks in India against
losses arising out of risk of confirmation of L/C. the risks can be either political or commercial or both.
Loss due to political risks is covered up to 90 % and that due to commercial risks up to 75%.
2. Insurance Cover for Buyer’s Credit and Lines of Credit: Financial Institutions in India have
started direct lending to buyers or financial institutions in developing countries for importing machinery
and equipment from India. This sort of financing facilitates immediate payment to exporters and frees
them from the problem of credit management. ECGC has evolved this scheme to protect financial
institutions in India which extent export credit to overseas buyers or institutions.
3. Overseas Investment Insurance: with the increasing exports of capital goods and turnkey
projects from India, the involvement of exporters in capital anticipation in overseas projects has assumed
importance. ECGC has evolved this scheme to provide protection for such investment. Normally the
insurance cover is for 15 years.
 Export financing programmes provided by EXIM Bank India

EXIM INDIA offers a range of financing programs that match the menu of Exim Banks of the industrialized
countries. However, the Bank is atypical in the universe of Exim Banks in that it has over the years
evolved, so as to anticipate and meet the special needs of a developing country. The Bank provides
competitive finance at various stages of the export cycle covering:
EXIM INDIA operates a wide range of financing and promotional programs. The Bank finances exports of
Indian machinery, manufactured goods, and consultancy and technology services on deferred payment
terms. EXIM INDIA also seeks to co finance projects with global and regional development agencies to
assist Indian exporters in their efforts to participate in such overseas projects.
The Bank is involved in promotion of two-way technology transfer through the outward flow of investment
in Indian joint ventures overseas and foreign direct investment flow into India. EXIM INDIA is also a
Partner Institution with European Union and operates European Community Investment Partners’
Program (ECIP) for facilitating promotion of joint ventures in India through technical and financial
collaboration with medium sized firms of the European Union.
The Export- Import Bank of India (Exim Bank) provides financial assistance to promote Indian exports
through direct financial assistance, overseas investment finance, term finance for export production and
export development, pre-shipping credit, buyer’s credit, lines of credit, relending facility, export bills
rediscounting, refinance to commercial banks.
Loans to Indian Entities
 Deferred payment exports: Term finance is provided to Indian exporters of eligible goods and
services, which enables them to offer deferred credit to overseas buyers. Deferred credit can also cover
Indian consultancy, technology and other services. Commercial banks participate in this program
directly or under risk syndication arrangements.
 Pre-shipment credit: finance is available form Exim Bank for companies executing export
contracts involving cycle time exceeding six months. The facility also enables provision of rupee
mobilization expenses for construction/turnkey project exporters.
 Term loans for export production: Exim Bank provides term loans/deferred payment
guarantees to 100% export-oriented units, units in free trade zones and computer software exporters. In
collaboration with International Finance Corporation. Washington, Exim Bank provides loans to enable
small and medium enterprises upgrade export production capability. Facilities for deeded exports;
Deemed exports are eligible for funded and non- funded facilities from Exim Bank.
 Overseas Investment finance: Indian companies establishing joint ventures overseas are
provided finance towards their equity contribution in the joint venture.
 Finance for export marketing: This program, which is a component of a World Bank loan, helps
exporters implement their export market development plans.
Loans to Commercial Banks in India
 Export Bills Rediscounting: Commercial Banks in India who are authorized to deal in foreign
exchange can rediscount their short term export bills with Exim Banks, for an unexpired usance period
of not more than 90 days.
 Refinance of Export Credit: Authorized dealers in foreign exchange can obtain from Exim Bank
100% refinance of deferred payment loans extended for export of eligible Indian goods.
 · Guaranteeing of Obligations: 
Exim Bank participates with commercial banks in India in the issue of guarantees required by Indian
companies for the export contracts and for execution of overseas construction and turnkey projects.
Loans to Overseas Entities
 Overseas Buyer’s Credit: Credit is directly offered to foreign entities for import of eligible goods
and related services, on deferred payment.
 Lines of Credit: Besides foreign governments, finance is available to foreign financial institutions
and government agencies to on-lend in the respective country for import of goods and services from
India.
 Relending Facility to Banks Overseas: Relending facility is extended to banks overseas to
enable them to provide term finance to their client’s worldwide for imports from India.
 Factoring Concept in Export Finance

Factoring may be defined as “A contract by which the factor is to provide at least two of the services,
(finance, the maintenance of accounts, the collection of receivables and protection against credit risks)
and the supplier is to assigned to the factor on a continuing basis by way of sale or security, receivables
arising from the sale of goods or supply of services”.
Factoring offers smaller companies the instant cash advantage that was once available only to large
companies with high sales volumes. With Factoring, there’s no need for credit or collection departments,
and no need to spend your profits on maintaining accounts receivables.
In simple words…Factoring turns your receivable into cash today, instead of waiting to be paid at a future
date.
International export Factoring Scheme:
RBI  has  approved  the  above scheme  evolved  by SBI  Factors  and Commercial Services  Pvt. Ltd
Mumbai   for  providing “International Export Factoring Services” on “with recourse” basis.  The salient
features of   the scheme are as follows:
 An exporter should submit to SBI  Factors & Commercial Services Pvt.Ltd i.e. the Export
Factor(EF) a list of Buyers(customers) indicating their names & street addresses and his credit line
needs .
 The Import Factor (IF) located in the importer’s country selected by EF, will rate the buyer’s list
and the results will be reported to the exporter through EF. The exporter will apply for a credit limit in
respect of overseas importer. IF will grant credit line based on the assessment of credit-worthiness of
the overseas importer.
 The exporter will thereafter enter into an export factoring agreement with EF. All export receivable
will be assigned to the EF, who in turn will assign them to IF.
 The exporter will ship merchandise to approved foreign buyers. Each   invoice is made payable to
a specific factor in the buyer’s (importer) country. Copies of invoices & shipping documents should be
sent to IF through EF. EF will make prepayment   to the exporter   against   approved export
receivables.
 EF will report the transaction in relevant ENC statement detailing full particulars, such as
Exporter’s Code Number, GR Form Number, Custom Number, Currency, Invoice value etc.
 On receipt of payments from buyers on the due date of invoice, IF will remit funds to EF who will
convert foreign currency remittances into rupees   and will transfer proceeds to the exporter after
deducting the amount of prepayments, if made. Simultaneously, EF will report the transaction in the
relative ‘R’ returns enclosing duplicate copy of the respective GR form duly certified. The payment
received will be the net payment after deduction of a service fee, which ranges from 0.5 % to 2% of the
value of the invoices.
 If an approved buyer (importer) is unable to pay the proceeds of exports, IF will pay the
receivables to EF, 100 days after the due date. The   transactions of this nature will be reported by EF in
the half yearly statements which are to be submitted to RBI, indicating therein the reasons for delay
/non payment.

The concept of Forfeiting in Export Finance

Forfeiting is a mechanism of financing exports.

 By discounting export receivables
 Evidenced by bills of exchange or promissory notes
 Without recourse to the seller (viz. exporter)
 Carrying medium to long term maturities
 On a fixed rate basis (discount)
 Upto 100 percent of the contract value.
The word `forfeit’ is derived from the French word `a forfeit’ which means the surrender of rights.
Simply put, Forfeiting is the non-recourse discounting of export receivables. In a forfeiting transaction, the
exporter surrenders, without recourse to him, his rights to claim for payment on goods delivered to an
importer, in return for immediate cash payment from a forfeiter. As a result, an exporter in India can
convert a credit sale into a cash sale, with no recourse to the exporter or his banker.
Concept of forfeiting:
1. What exports are eligible for forfeiting?
All exports of capital goods and other goods made on medium to long term credit are eligible to be
financed through forfeiting.
2. How does forfeiting work?
Receivables under a deferred payment contract for export of goods, evidenced by bills of exchange or
promissory notes, can be forfaited.
Bills of exchange or promissory notes, backed by co-acceptance from a bank (which would generally be
the buyer’s bank), are endorsed by the exporter, without recourse, in favour of the forfeiting agency in
exchange for discounted cash proceeds. The co-accepting bank must be acceptable to the forfeiting
agency.
3. Is there a prescribed format for the bills of exchange or promissory notes?
Yes. The bills of exchange or promissory notes should be in the prescribed format.
4. What role will Exim Bank play in forfeiting transactions?
The role of Exim Bank will be that of a facilitator between the Indian exporter and the overseas forfeiting
agency.
5. How will Exim Bank facilitate a forfeiting transaction?
 On a request from an exporter, for an export transaction which is eligible to be forfaited, Exim Bank will
obtain indicative and firm forfeiting quotes – discount rate, commitment and other fees – from overseas
agencies.
Exim Bank will receive availed bills of exchange or promissory notes, as the case may be, and send them
to the forfeiter for discounting and will arrange for the discounted proceeds to be remitted to the Indian
exporter.
Exim Bank will issue appropriate certificates to enable Indian exporters to remit commitment fees and
other charges.
6. What does forfeiting cost include?
A forfeiting transaction has typically three cost elements:
 Commitment fee
 Discount fee
 Documentation fee
7. What benefits accrue to an exporter from forfeiting?
 Converts a deferred payment export into a cash transaction, improving liquidity and cash flow
 Frees the exporter from cross-border political or commercial risks associated with export
receivables
 Finance up to 100 percent of the export value is possible as compared to 80-85 percent financing
available from conventional export credit program
 As forfeiting offers without recourse finance to an exporter, it does not impact the exporter’s
borrowing limits. Thus, forfeiting represents an additional source of funding, contributing to improved
liquidity and cash flow
 Provides fixed rate finance; hedges against interest and exchange risks arising from deferred
export credit
 Exporter is freed from credit administration and collection problems
 Forfaiting is transaction specific. Consequently, a long term banking relationship with the forfeiter
is not necessary to arrange a forfeiting transaction
 Exporter saves on insurance costs as forfeiting obviates the need for export credit insurance

LETTER OF CREDIT

Letter of Credit is one of the most popular and more secured of method of payment in recent times as
compared to other methods of payment. A L/C Letter of Credit ) refers to the documents representing the
goods and not the goods themselves. Banks are not in the business of examining the goods on behalf of
the customers. Typical documents, which are required includes commercial invoice, transport document
such as Bill of lading or Airway bill, an insurance documents etc. L/C deals in documents and not goods.
 DEFINITION:
A Letter of Credit can be defined as “an undertaking by importer’s bank stating that payment will be made
to the exporter if the required documents are presented to the bank within the validity of the L/C”.

PARTIES INVOLVED IN LETTER OF CREDIT:

1. Applicant: The buyer or importer of goods
2. Issuing bank: Importer’s bank, who issues the L/C
3. Beneficiary: The party to whom the L/C is addressed. The Seller or supplier of goods.
4. Advising bank: Issuing bank’s branch or correspondent bank in the exporter’s country to whom
the L/C is send for onward transmission to the beneficiary.
5. Confirming bank: The bank in beneficiary’s country, which guarantees the credit on the request
of the issuing bank.
6. Negotiating bank: The bank to whom the beneficiary presents his documents for payment under
L/C
A Letter of Credit contains these elements:
 A payment undertaking given by the bank (issuing bank) on behalf of the buyer (applicant)
 To pay a seller (beneficiary) a given amount of money          on presentation of specified
documents representing the supply of goods within specific time limits
 These documents conforming to terms and conditions set out in the letter of credit
 Documents to be presented at a specified place.
In simple words, the Issuing Bank’s role is twofold:
 To guarantee to the seller that if complete documents are presented, the bank will pay the seller
the amount due. This offers security to the seller – the bank says in effect “We will pay you if you
present documents (XYZ)”
 To examine the documents and only pay if these comply with the terms and conditions set out in
the letter of credit. This protects the buyer’s interests – the bank says “We will only pay your supplier on
your behalf if they present documents (XYZ) that you have asked for”
ADVANTAGES OF LETTER OF CREDIT
Advantages to the Exporter:
 No blocking of funds.
 Clearance of import regulations.
 Free from liability.
 Pre- shipment finance.
 Non-refusal by importer.
 Reduction in bad-debts.
Advantages to the Importer:
 Better terms of trade.
 Assurance of shipment of goods.
 Overdraft facility.
 No blocking of funds.
 Delivery on time.
 Better relations.
DISADVANTAGES OF LETTER OF CREDIT:
 Lacks flexibility.
 Complex method
 Expensive for importer
 Problem of revocable L/C
Sample Document: Letter of Credit (Documentary Credit)
THE MOON BANK
INTERNATIONAL OPERATIONS
5 MOONLIGHT BLVD.,
EXPORT-CITY AND POSTAL CODE
EXPORT-COUNTRY
OUR ADVICE NO. ISSUING BANK REF. NO. & DATE
MB-5432 SBRE-777     January 26, 2005
To,
UVW Exports
88 Prosperity Street East, Suite 707
Export-City and Postal Code

Dear Sirs:
We have been requested by The Sun Bank, Sunlight City, Import-Country to advise that
they have opened with us their irrevocable documentary credit number SB-87654
For account of DEF Imports, 7 Sunshine Street, Sunlight City, Import-Country in your favor for the amount of
not exceeding Twenty Five Thousand U.S. Dollars (US$25,000.00) available by your draft(s) drawn on us  at
sight for full invoice value

Accompanied by the following documents:

1. Signed commercial invoice in five (5) copies indicating the buyer’s
Purchase Order No. DEF-101 dated January 10, 2005
2. Packing list in five (5) copies.
3. . Full set 3/3 clean on board ocean bill of lading, plus two (2) non-negotiable copies,
issued to order of The Sun Bank, Sunlight City, Import-Country, notify the above
accountee, marked “freight Prepaid”, dated latest March 19, 2005, and showing
documentary credit number.
4. Insurance policy in duplicate for 110% CIF value covering Institute Cargo Clauses
 (A), Institute War and Strike Clauses, evidencing that claims are payable in Import-
Country.
Covering:     100 Sets ‘ABC’ Brand Pneumatic Tools, 1/2″ drive,
complete with hose and quick couplings, CIF Sunny Port

Shipment from: Moonbeam Port, Export-Country to Sunny Port, Import-Country

Partial shipment Prohibited
Tran-shipment Permitted
Special conditions:
1. All documents indicating the Import License No. IP/123456 dated January 18, 2005.
2. All charges outside the Import-Country are on beneficiary’s account
Documents must be presented for payment within 15 days after the date of shipment.
Draft(s) drawn under this credit must be marked
Drawn under documentary credit No. SB-87654 of The Sun Bank,
Sunlight City, Import-Country, dated January 26, 2005

We confirm this credit and hereby undertake that all drafts drawn under and in conformity
with the terms of this credit will be duly honored upon delivery of documents as specified,
if presented at this office on or before     March 26, 2005
Very truly yours,
__________________________
Authorized Signature
Unless otherwise expressly stated, this Credit is subject to the Uniform Customs and Practice for
Documentary Credits, 1993 Revision, International Chamber of Commerce Publication No. 500.

POST SHIPMENT FINANCE

Post shipment finance is provided to meet working capital requirements after the actual shipment of
goods. It bridges the financial gap between the date of shipment and actual receipt of payment from
overseas buyer thereof. Whereas the finance provided after shipment of goods is called post-shipment
finance.
DEFINITION:
Credit facility extended to an exporter from the date of shipment of goods till the realization of the export
proceeds is called Post-shipment Credit.
IMPORTANCE OF FINANCE AT POST-SHIPMENT STAGE:
 To pay to agents/distributors and others for their services.
 To pay for publicity and advertising in the over seas markets.
 To pay for port authorities, customs and shipping agents charges.
 To pay towards export duty or tax, if any.
 To pay towards ECGC premium.
 To pay for freight and other shipping expenses.
 To pay towards marine insurance premium, under CIF contracts.
 To meet expenses in respect of after sale service.
 To pay towards such expenses regarding participation in exhibitions and trade fairs in India and
abroad.
 To pay for representatives abroad in connection with their stay board.
FORMS/METHODS OF POST SHIPMENT FINANCE
 Export bills negotiated under L/C: The exporter can claim post-shipment finance by drawing
bills or drafts under L/C. The bank insists on necessary documents as stated in the L/C. if all documents
are in order, the bank negotiates the bill and advance is granted to the exporter.
 Purchase of export bills drawn under confirmed contracts: The banks may sanction advance
against purchase or discount of export bills drawn under confirmed contracts. If the L/C is not available
as security, the bank is totally dependent upon the credit worthiness of the exporter.
 Advance against bills under collection: In this case, the advance is granted against bills drawn
under confirmed export order L/C and which are sent for collection. They are not purchased or
discounted by the bank. However, this form is not as popular as compared to advance purchase or
discounting of bills.
 Advance against claims of Duty Drawback (DBK): DBK means refund of customs duties paid
on the import of raw materials, components, parts and packing materials used in the export production.
It also includes a refund of central excise duties paid on indigenous materials. Banks offer pre-shipment
as well as post-shipment advance against claims for DBK.
 Advance against goods sent on Consignment basis: The bank may grant post-shipment
finance against goods sent on consignment basis.
 Advance against Undrawn Balance of Bills: There are cases where bills are not drawn to the
full invoice value of gods. Certain amount is undrawn balance which is due for payment after
adjustments due to difference in rates, weight, quality etc. banks offer advance against such undrawn
balances subject to a maximum of 5% of the value of export and an undertaking is obtained to
surrender balance proceeds to the bank.
 Advance against Deemed Exports: Specified sales or supplies in India are considered as
exports and termed as “deemed exports”. It includes sales to foreign tourists during their stay in India
 and supplies made in India to IBRD/ IDA/ ADB aided projects. Credit is offered for a maximum of 30
days.
 Advance against Retention Money: In respect of certain export capital goods and project
exports, the importer retains a part of cost goods/ services towards guarantee of performance or
completion of project. Banks advance against retention money, which is payable within one year from
date of shipment.
 Advance against Deferred payments: In case of capital goods exports, the exporter receives
the amount from the importer in installments spread over a period of time. The commercial bank
together with EXIM bank do offer advances at concessional rate of interest for 180 days.
SOME SCHEMES UNDER OPERATION IN PRE-SHIPMENT FINANCE
1. DEFERRED CREDIT
Meaning:
Consumer goods are normally sold on short term credit, normally for a period upto 180 days. However,
there are cases, especially, in the case of export of capital goods and technological services; the credit
period may extend beyond 180 days. Such exports were longer credit terms (beyond 180 days) is allowed
by the exporter is called as “deferred credit” or “deferred payment terms”.
How the payment is received?
The payment of goods sold on “deferred payment terms” is received partly by way of advance or down
payment, and the balance being payable in installments spread over a period of time.
Period of financial credit support:
Financial institutions extend credit for goods sold on “deferred payment terms” (subject to approval from
RBI, if required). The credit extended for financing such deferred payment exports is known as Medium
Term and Long Term Credit. The medium credit facilities are provided by the commercial banks together
with EXIM Bank for a period upto 5 years. The long term credit is offered normally between 5 yrs to 12
yrs, and it is provided by EXIM Bank.
Amount of credit support:
Any loan upto Rs.10crore for financing export of capital goods on deferred payment terms is sanctioned
by the commercial bank which can refinance itself from Exim bank. In case of contracts above Rs.10
Lakhs but not more than Rs50crore, the EXIM Bank has the authority to decide whether export finance
could be provided. Contracts above Rs.50crore need the clearance from the working group on Export
Finance.
2. REDISCOUNTING OF EXPORT BILLS ABROAD   (EBRD) SCHEME:
The exporter has the option of availing of export credit at the post-shipment stage either in rupee    or in
foreign currency under the rediscounting of export bills abroad   (EBRD) scheme   at LIBOR linked
interest rates.
This facility will be an additional window available to exporter along   with the exiting   rupee financing
schemes to an exporter at post shipment stage.  This facility will be available in all convertible currencies.
This scheme  will cover   export  bills  upto  180  days   from the date  of  shipment  (inclusive   of 
normal   transit  period   and  grace period) .
 The scheme  envisages  ADs   rediscounting  the  export   bills  in overseas   markets   by making
arrangements    with an overseas  agency/ bank   by way  of  a  line  of credit   or  banker’s acceptance  
facility   or  any  other  similar   facility at rates   linked to London Inter Bank   Offered   Rate (LIBOR)
for  six  months.
Prior  permission  of RBI  will not  be  required   for  arranging   the  rediscounting  facility  abroad so  long
as  the  spread  for  rediscounting facility  abroad does   not exceed   one  percent  over the  six  months  
LIBOR  in the case   of rediscounting  ‘with recourse’  basis & 1.5%   in the case   of   ‘without recourse’
facility. Spread, should    be exclusive   of any withholding tax.  In all   other cases, the RBI’s permission
will be needed.
3. FINANCE FOR RUPEE EXPENDITURE FOR PROJECT EXPORT CONTRACTS (FREPEC)
1. What is FREPEC Program?
This program seeks to Finance Rupee Expenditure for Project Export Contracts, incurred by Indian
companies.
2. What is the purpose of this Credit?
To enable Indian project exporters to meet Rupee expenditure incurred/required to be incurred for
execution of overseas project export contracts such as for acquisition/purchase/acquisition of materials
and equipment, acquisition of personnel, payments to be made in India to staff, sub-contractors,
consultants and to meet project related overheads in Indian Rupees.
3. Who are eligible for Assistance under FREPEC Program?
Indian project exporters who are to execute project export contracts overseas secure on cash payment
terms or those funded by multilateral agencies will be eligible. The purpose of the new lending program is
to give boost to project export efforts of companies with good track record and sound financials.
4. What is the quantum of credit extended under this program?
Up to 100% of the peak deficit as reflected in the Rupee cash flow statement prepared for the project.
Exim Bank will not normally take up cases involving credit requirement below Rs. 50 lakhs. Although, no
maximum amount of credit is being proposed, while approving overall credit limit, credit-worthiness of the
exporter-borrower would be taken into account. Where feasible, credit may be extended in participation
with sponsoring commercial banks.
5. How are Disbursements made under this Program?
Disbursements will made in Rupees through a bank account of the borrower-company against
documentary evidence of expenditure incurred accompanied by a certificate of Chartered Accountants.
6. How is a FREPEC Loan to be extinguished?
Repayment of credit would normally be out of project receipts. Period of repayment would depend upon
the project cash flow statements, but will not exceed 4 (four) years from the effective date of project
export contract. The liability of the borrower to repay the credit and pay interest and other monies will be
absolute and will not be dependent upon actual realization of project bills.
7. What is the security stipulated for FREPEC loan?
Hypothecation of project receivables and project movables.
Optional: where available
 Personal Guarantees of Directors of the Company.
 Available collateral security.
 PRESHIPMENT FINANCE

Pre-shipment is also referred as “packing credit”. It is working capital finance provided by commercial
banks to the exporter prior to shipment of goods. The finance required to meet various expenses before
shipment of goods is called pre-shipment finance or packing credit.
DEFINITION:
Financial assistance extended to the exporter from the date of receipt of the export order till the date of
shipment is known as pre-shipment credit. Such finance is extended to an exporter for the purpose of
procuring raw materials, processing, packing, transporting, warehousing of goods meant for exports.
IMPORTANCE OF FINANCE AT PRE-SHIPMENT STAGE:
 To purchase raw material, and other inputs to manufacture goods.
 To assemble the goods in the case of merchant exporters.
 To store the goods in suitable warehouses till the goods are shipped.
 To pay for packing, marking and labelling of goods.
 To pay for pre-shipment inspection charges.
 To import or purchase from the domestic market heavy machinery and other capital goods to
produce export goods.
 To pay for consultancy services.
 To pay for export documentation expenses.
FORMS OR METHODS OF PRE-SHIPMENT FINANCE:
1. Cash Packing Credit Loan:
In this type of credit, the bank normally grants packing credit advantage initially on unsecured basis.
Subsequently, the bank may ask for security.
2. Advance Against Hypothecation:
Packing credit is given to process the goods for export. The advance is given against security and the
security remains in the possession of the exporter. The exporter is required to execute the hypothecation
deed in favour of the bank.
3. Advance Against Pledge:
The bank provides packing credit against security. The security remains in the possession of the bank.
On collection of export proceeds, the bank makes necessary entries in the packing credit account of the
exporter.
4. Advance Against Red L/C:
The Red L/C received from the importer authorizes the local bank to grant advances to exporter to meet
working capital requirements relating to processing of goods for exports. The issuing bank stands as a
guarantor for packing credit.
5. Advance Against Back-To-Back L/C:
 The merchant exporter who is in possession of the original L/C may request his bankers to issue Back-
To-Back L/C against the security of original L/C in favour of the sub-supplier. The sub-supplier thus gets
the Back-To-Bank L/C on the basis of which he can obtain packing credit.
6. Advance Against Exports Through Export Houses:
Manufacturer, who exports through export houses or other agencies can obtain packing credit, provided
such manufacturer submits an undertaking from the export houses that they have not or will not avail of
packing credit against the same transaction.
7. Advance Against Duty Draw Back (DBK):
DBK means refund of customs duties paid on the import of raw materials, components, parts and packing
materials used in the export production. It also includes a refund of central excise duties paid on
indigenous materials. Banks offer pre-shipment as well as post-shipment advance against claims for
DBK.
8. Special Pre-Shipment Finance Schemes:
 Exim-Bank’s scheme for grant for Foreign Currency Pre-Shipment Credit (FCPC) to exporters.
 Packing credit for Deemed exports.
SOME SCHEMES IN PRE-SHIPMENT STAGE OF FINANCE
1.  PACKING CREDIT
SANCTION OF PACKING CREDIT ADVANCES:
There are certain factors, which should be considered while sanctioning the packing credit advances viz.
1. Banks may relax norms for debt-equity ratio, margins etc but no compromise in respect of viability
of the proposal and integrity of the borrower.
2. Satisfaction about the capacity of the execution of the orders within the stipulated time and the
management of the export business.
3. Quantum of finance.
4. Standing of credit opening bank if the exports are covered under letters of credit.
5. Regulations, political and financial conditions of the buyer’s country.
DISBURSEMENT OF PACKING CREDIT:
After proper sanctioning of credit limits, the disbursing branch should ensure:
To inform ECGC the details of limit sanctioned in the prescribed format within 30 days from the date of
sanction.
a)      To complete proper documentation and compliance of the terms of sanction i.e. creation of
mortgage etc.
b)      There should be an export order or a letter of credit produced by the exporter on the basis of which
disbursements are normally allowed.
In both the cases following particulars are to be verified:
1. Name of the Buyer.
2. Commodity to be exported.
3. Quantity.
4. Value.
5. Date of Shipment / Negotiation.
6. Any other terms to be complied with.
2.   FOREIGN CURRENCY PRE-SHIPMENT CREDIT (FCPC)
 The FCPC is available to exporting companies as well as commercial banks for lending to the
former.
 It is an additional window to rupee packing credit scheme & available to cover both the domestic
i.e. indigenous & imported inputs. The exporter has two options to avail him of export finance.
 To avail him of pre-shipment credit in rupees & then the post shipment credit either in rupees or in
foreign currency denominated credit or discounting /rediscounting of export bills.
 To avail of pre-shipment credit in foreign currency & discounting/rediscounting of the export bills
in foreign currency.
 FCPC will also be available both to the supplier EOU/EPZ unit and the receiver EOU/EPZ unit.
Pre-shipment credit in foreign currency shall also be available on exports to ACU (Asian Clearing
Union)countries with effect from 1.1.1996.
Eligibility: PCFC is extended only on the basis of confirmed /firms export orders or confirmed L/C’s. The
“Running account facility will not be available under the scheme.  However, the facility of the liquidation of
packing credit under the first in first out method will be allowed.
Order or L/C : Banks  should not  insist   on  submission  of  export   order  or  L/C  for  every
disbursement    of  pre-shipment   credit , from exporters   with consistently   good  track  record.  Instead,
a system of periodical submission of a statement of L/C’s or export orders in hand, should be introduced.
Sharing of FCPC: Banks may extend FCPC to the manufacturer also on the basis of the disclaimer from
the export order.

INTRODUCTION T O EXPORT FINANCE

Credit and finance is the life and blood of any business whether domestic or international. It is more
important in the case of export transactions due to the prevalence of novel non-price competitive
techniques encountered by exporters in various nations to enlarge their share of world markets.
The selling techniques are no longer confined to mere quality; price or delivery schedules of the products
but are extended to payment terms offered by exporters. Liberal payment terms usually score over the
competitors not only of capital equipment but also of consumer goods.
The payment terms however depend upon the availability of finance to exporters in relation to its
quantum, cost and the period at pre-shipment and post-shipment stage.
Production and manufacturing for substantial supplies for exports take time, in case finance is not
available to exporter for production. They will not be in a position to book large export order if they don’t
 have sufficient financial funds. Even merchandise exporters require finance for obtaining products from
their suppliers.
This project is an attempt to throw light on the various sources of export finance available to exporters,
the schemes implemented by ECGC and EXIM for export promotion and the recent developments in the
form of tie-EXIM tie-ups, credit policy announced by RBI in Oct 2001 and TRIMS.
Concept of Export Finance:
The exporter may require short term, medium term or long term finance depending upon the types of
goods to be exported and the terms of statement offered to overseas buyer.
The short-term finance is required to meet “working capital” needs. The working capital is used to meet
regular and recurring needs of a business firm. The regular and recurring needs of a business firm refer to
purchase of raw material, payment of wages and salaries, expenses like payment of rent, advertising etc.
The exporter may also require “term finance”. The term finance or term loans, which is required for
medium and long term financial needs such as purchase of fixed assets and long term working capital.
Export finance is short-term working capital finance allowed to an exporter. Finance and credit are
available not only to help export production but also to sell to overseas customers on credit.
Objectives of Export Finance:
 To cover commercial & Non-commercial or political risks attendant on granting credit to a foreign
buyer.
 To cover natural risks like an earthquake, floods etc.
An exporter may avail financial assistance from any bank, which considers the ensuing factors:
a)      Availability of the funds at the required time to the exporter.
b)      Affordability of the cost of funds.
Appraisal:
Appraisal means an approval of an export credit proposal of an exporter. While appraising an export
credit proposal as a commercial banker, obligation to the following institutions or regulations needs to be
adhered to.
Obligations to the RBI under the Exchange Control Regulations are:
 Appraise to be the bank’s customer.
 Appraise should have the Exim code number allotted by the Director General of Foreign Trade.
 Party’s name should not appear under the caution list of the RBI.
Obligations to the Trade Control Authority under the EXIM policy are:
 Appraise should have IEC number allotted by the DGFT.
 Goods must be freely exportable i.e. not falling under the negative list. If it falls under the negative
list, then a valid license should be there which allows the goods to be exported.
 Country with whom the Appraise wants to trade should not be under trade barrier.
Obligations to ECGC are:
 Verification that Appraise is not under the Specific Approval list (SAL).
 Sanction of Packing Credit Advances.
Guidelines for banks dealing in Export Finance:
When a commercial bank deals in export finance it is bound by the ensuing guidelines: -
a)      Exchange control regulations.
b)      Trade control regulations.
c)      Reserve Bank’s directives issued through IECD.
d)     Export Credit Guarantee Corporation guidelines.
e)      Guidelines of Foreign Exchange Dealers Association of India.

FMEA

The Foreign Exchange Regulation Act of 1973 (FERA) in India was repealed on 1st June, 2000. It was
replaced by theForeign Exchange Management Act (FEMA), which was passed in the winter session of
Parliament in 1999. Enacted in 1973, in the backdrop of acute shortage of Foreign Exchange in the
country, FERA had a controversial 27 year stint during which many bosses of the Indian Corporate world
found themselves at the mercy of the Enforcement Directorate (E.D.). Any offense under FERA was a
criminal offense liable to imprisonment, whereas FEMA seeks to make offenses relating to foreign
exchange civil offenses. FEMA, which has replaced FERA, had become the need of the hour since FERA
had become incompatible with the pro-liberalization policies of the Government of India. FEMA has
brought a new management regime of Foreign Exchange consistent with the emerging frame work of the
World Trade Organization (WTO).  It is another matter that enactment of FEMA also brought with it
Prevention of Money Laundering Act, 2002 which came into effect recently from 1st July, 2005 and the
heat of which is yet to be felt as “Enforcement Directorate” would be investigating the cases under PMLA
too.
Unlike other laws where everything is permitted unless specifically prohibited, under FERA nothing was
permitted unless specifically permitted. Hence the tenor and tone of the Act was very drastic. It provided
for imprisonment of even a very minor offence. Under FERA, a person was presumed guilty unless he
proved himself innocent whereas under other laws, a person is presumed innocent unless he is proven
guilty.
Objectives and Extent of FEMA
The objective of the Act is to consolidate and amend the law relating to foreign exchange with the
objective of facilitating external trade and payments and for promoting the orderly development and
maintenance of foreign exchange market in India. FEMA extends to the whole of India. It applies to all
branches, offices and agencies outside India owned or controlled by a person who is a resident of India
and also to any contravention there under committed outside India by any person to whom this Act
applies.
Except with the general or special permission of the Reserve Bank of India, no person can :-
 deal in or transfer any foreign exchange or foreign security to any person not being an authorized
person;
 make any payment to or for the credit of any person resident outside India in any manner;
 receive otherwise through an authorized person, any payment by order or on behalf of any
person resident outside India in any manner;
 reasonable restrictions for current account transactions as may be prescribed.
Any person may sell or draw foreign exchange to or from an authorized person for a capital account
transaction. The Reserve Bank may, in consultation with the Central Government, specify :-
 any class or classes of capital account transactions which are permissible;
 the limit up to which foreign exchange shall be admissible for such transactions
However, the Reserve Bank cannot impose any restriction on the drawing of foreign exchange for
payments due on account of amortization of loans or for depreciation of direct investments in the ordinary
course of business.
The Reserve Bank can, by regulations, prohibit, restrict or regulate the following :-
 Transfer or issue of any foreign security by a person resident in India;
 Transfer or issue of any security by a person resident outside India;
 Transfer or issue of any security or foreign security by any branch, office or agency in India of a
person resident outside India;
 Any borrowing or lending in foreign exchange in whatever form or by whatever name called;
 Any borrowing or tending in rupees in whatever form or by whatever name called between a
person resident in India and a person resident outside India;
 Deposits between persons resident in India and persons resident outside India;
 Export, import or holding of currency or currency notes;
 Transfer of immovable property outside India, other than a lease not exceeding five years, by a
person resident in India;
 Acquisition or transfer of immovable property in India, other than a lease not exceeding five
years, by a person resident outside India;
 Giving of a guarantee or surety in respect of any debt, obligation or other liability incurred
(i) by a person resident in India and owed to a person resident outside India or
(ii) by a person resident outside India.
A person, resident in India may hold, own, transfer or invest in foreign currency, foreign security or any
immovable property situated outside India if such currency, security or property was acquired, held or
owned by such person when he was resident outside India or inherited from a person who was resident
outside India.
A person resident outside India may hold, own, transfer or invest in Indian currency, security or any
immovable property situated in India if such currency, security or property was acquired, held or owned by
such person when he was resident in India or inherited from a person who was resident in India.
 The Reserve Bank may, by regulation, prohibit, restrict, or regulate establishment in India of a branch,
office or other place of business by a person resident outside India, for carrying on any activity relating to
such branch, office or other place of business. Every exporter of goods and services must :-
 Furnish to the Reserve Bank or to such other authority a declaration in such form and in such
manner as may be specified, containing true and correct material particulars, including the amount
representing the full export value or, if the full export value of the goods is not ascertainable at the time
of export, the value which the exporter, having regard to the prevailing market conditions, expects to
receive on the sale of the goods in a market outside India;
 Furnish to the Reserve Bank such other information as may be required by the Reserve Bank for
the purpose of ensuring the realization of the export proceeds by such exporter.
The Reserve Bank may, for the purpose of ensuring that the full export value of the goods    or such
reduced value of the goods as the Reserve Bank determines, having regard to the prevailing market-
conditions, is received without any delay, direct any exporter to comply with such requirements as it
deems fit. Where any amount of foreign exchange is due or has accrued to any person resident in India,
such person shall take all reasonable steps to realize and repatriate to India such foreign exchange within
such period and in such manner as may be specified by the Reserve Bank.
FEMA Rules & Policies
The Foreign Exchange Management Act, 1999 (FEMA) came into force with effect from June 1, 2000.
With the introduction of the new Act in place of FERA, certain structural changes were brought in. The Act
consolidates and amends the law relating to foreign exchange to facilitate external trade and payments,
and to promote the orderly development and maintenance of foreign exchange in India.
From the NRI perspective, FEMA broadly covers all matters related to foreign exchange, investment
avenues for NRIs such as immovable property, bank deposits, government bonds, investment in shares,
units and other securities, and foreign direct investment in India.
FEMA vests with the Reserve Bank of India, the sole authority to grant general or special permission for
all foreign exchange related activities mentioned above.
Section 2 - The Act here provides clarity on several definitions and terms used in the context of foreign
exchange. Starting with the identification of the Non-resident Indian and Persons of Indian origin, it
defines “foreign exchange” and “foreign security” in sections 2(n) and 2(o) respectively of the Act. It
describes at length the foreign exchange facilities and where one can buy foreign exchange in India.
FEMA defines an authorised dealer, and addresses the permissible exchange allowed for a business trip,
for studies and medical treatment abroad, forex for foreign travel, the use of an international credit card,
and remittance facility
Section 3 prohibits dealings in foreign exchange except through an authorised person. Similarly, without
the prior approval of the RBI, no person can make any payment to any person resident outside India in
any manner other than that prescribed by it. The Act restricts non-authorised persons from entering into
any financial transaction in India as consideration for or in association with acquisition or creation or
transfer of a right to acquire any asset outside India.
Section 4 restrains any person resident in India from acquiring, holding, owning, possessing or
transferring any foreign exchange, foreign security or any immovable property situated outside India
except as specifically provided in the Act.
 Section 6 deals with capital account transactions. This section allows a person to draw or sell foreign
exchange from or to an authorised person for a capital account transaction. RBI in consultation with the
Central Government has issued various regulations on capital account transactions in terms of sub-sect
ion (2) and (3) of section 6.
Section 7 covers the export of goods and services. All exporters are required to furnish to the RBI or any
other authority, a declaration regarding full export value.
Section 8 puts the responsibility of repatriation on the persons resident in India who have any amount of
foreign exchange due or accrued in their favour to get the same realised and repatriated to India within
the specific period and in the manner specified by the RBI.
The duties and liabilities of the Authorised Dealers have been dealt with in Sections 10, 11 and 12,
whileSections 13 to 15 cover penalties and enforcement of the orders of the Adjudicating Authority as
well as the power to compound contraventions under the Act.

FACTORS INFLUENCE EXCHANGE RATES

Foreign exchange rates are extremely volatile and it is incumbent on those involved with foreign
exchange – either as a purchaser, seller, speculator or institution – to know what causes rates to move.
Actually, there are a variety of factors – market sentiment, the state of the economy, government policy,
demand and supply and a host of others.
The more important factors that influence exchange rates are discussed below:
 Strength of the Economy :The strength of the economy affects the demand and supply of
foreign currency. If an economy is growing fast and is strong it will attract foreign currency thereby
strengthening its own. On the other hand, weaknesses result in an outflow of foreign exchange. If a
country is a net exporter (as were Japan and Germany), the inflow of foreign currency far outstrips the
outflow of their own currency. The result is usually a strengthening in its value.
 Political and Psychological Factors: Political or psychological factors are believed to have an
influence on exchange rates. Many currencies have a tradition of behaving in a particular way such as
Swiss francs which are known as a refuge or safe haven currency while the dollar moves (either up or
down) whenever there is a political crisis anywhere in the world. Exchange rates can also fluctuate if
there is a change in government. Some time back, India’s foreign exchange rating was downgraded
because of political instability and consequently, the external value of the rupee fell. Wars and other
external factors also affect the exchange rate. For example, when Bill Clinton was impeached, the US
dollar weakened. During the Indo-Pak war the rupee weakened. After the 1999 coup in Pakistan
(October/November 1999), the Pakistani rupee weakened.
 Economic Expectations :Exchange rates move on economic expectations. After the 1999
budget in India there was an expectation that the rupee would fall by 7% to 9%. Since such
expectations affect the external value of the rupee, all economic data – the balance of payments, export
 growth, inflation rates and the likes – are analysed and its likely effect on exchange rates is examined. If
the economic downturn is not as bad as anticipated the rate can even appreciate. The movement really
depends on the “market sentiment” – the mood of the market – and how much the market has reacted
or discounted the anticipated/expected information.
 Inflation Rates : It is widely held that exchange rates move in the direction required to
compensate for relative inflation rates. For instance, if a currency is already overvalued, i.e. stronger
than what is warranted by relative inflation rates, depreciation sufficient enough to correct that position
can be expected and vice versa. It is necessary to note that an exchange rate is a relative price and
hence the market weighs all the relative factors in relative terms (in relation to the counterpart
countries). The underlying reasoning behind this conviction is that a relatively high rate of inflation
reduces a country’s competitiveness and weakens its ability to sell in international markets. This
situation, in turn, will weaken the domestic currency by reducing the demand or expected demand for it
and increasing the demand or expected demand for the foreign currency (increase in the supply of
domestic currency and decrease in the supply of foreign currency).
 Capital Movements : Capital movements are one of the most important reasons for changes in
exchange rates. Capital movements of foreign currency are usually more than connected with
international trade. This occurs due to a variety of reasons – both positive and negative. When India
began its economic liberalisation and invited Foreign Institutional Investors (FIIs) to purchase equity
shares in Indian companies, billions of US dollars came into the country strengthening the currency. In
1996 and 1997, FIIs took several billion US dollars out of the country weakening the currency. These
were capital outflows. One of the reasons popularly believed for the rupee not depreciating in the
manner other South-east Asian currencies did in 1997-98 was because the rupee was not convertible
on the “capital account”.
 Speculation : Speculation in a currency raises or lowers the exchange rate. For instance, the
foreign exchange market in Kenya is very shallow. If a speculator enters and buys US $1 million, it will
raise the value of the US dollar significantly. If a few others do so too, the price of the US dollar will rise
even further against the Kenya shilling. The most famous speculator in foreign currency is Mr George
Soros who made over a billion pounds sterling in Europe (by correctly predicting the devaluation of the
pound) and then is believed to have triggered the free fall of the currencies of South-east Asia.
 . Balance of Payments : As mentioned earlier, a net inflow of foreign currency tends to
strengthen the home currency vis-à-vis other currencies. This is because the supply of the foreign
currency will be in excess of demand. A good way of ascertaining this would be to check the balance of
payments. If the balance of payments is positive and foreign exchange reserves are increasing, the
home currency will become stronger.
 Government’s Monetary and Fiscal Policies : Governments, through their monetary and fiscal
policies affect international trade, the trade balance and the supply and demand for a currency.
Increasing the supply of money raises prices and makes imports attractive. Fiscal surpluses will slow
economic growth and this will reduce demand for imports and encourage exports. The effectiveness of
the policy depends on the price and income elasticities of demand for the particular goods. High price
elasticity of demand means the volume of a good is sensitive to a change in price. Monetary and fiscal
policy support the currency through a reduction in inflation. These also affect exchange rate through the
capital account. Net capital inflows supply direct support for the exchange rate. Central governments
control monetary supply and they are expected to ensure that the government’s monetary policy is
followed. To this extent they could increase or decrease money supply. For example, the Reserve Bank
of India, to curb inflation, restricted and cut money supply. In Kenya, the central bank in order to attract
foreign money into the country is offering very high rates on its treasury bills. In order to maintain
exchange rates at a certain price the central bank will also intervene either by buying foreign currency
(when there is an excess in the supply of foreign exchange) and selling foreign currency (when demand
for foreign exchange exceeds supply). This is known as ‘central bank intervention’. It must be noted that
the objective of monetary policy is to maintain stability and economic growth and central banks are
expected to – by increasing/decreasing money supply, raising/lowering interest rates or by open market
operations – maintain stability.
 Exchange Rate Policy and Intervention: Exchange rates are also influenced, in no small
measure, by expectation of change in regulations relating to exchange markets and official intervention.
Official intervention can smoothen an otherwise disorderly market. As explained before, intervention is
the buying or selling of foreign currency to increase or decrease its supply. Central banks often
intervene to maintain stability. It has also been experienced that if the authorities attempt to half-
heartedly counter the market sentiments through intervention in the market, ultimately more steep and
sudden exchange rate swings can occur.
 Interest Rates : An important factor for movement in exchange rates in recent years is interest
rates, i.e. interest differential between major currencies. In this respect the growing integration of
financial markets of major countries, the revolution in telecommunication facilities, the growth of
specialised asset managing agencies, the deregulation of financial markets by major countries, the
emergence of foreign trading as profit centres per se and the tremendous scope for bandwagon and
squaring effects on the rates, etc. have accelerated the potential for exchange rate volatility.   Kenya
intrinsically has a very weak economy but the rates offered within the country have always been very
high. To illustrate this point the treasury bill rate in September 1998 was as high as 23%. High interest
rates attract speculative capital moves so the announcements made by the Federal Reserve on interest
 rates are usually eagerly awaited – an increase in the same will cause an inflow of foreign currency and
the strengthening of the US dollar.
 Tariffs and Quotas : Tariffs and quotas exist to protect a country’s foreign exchange by reducing
demand. Till before liberalisation, India followed a policy of tariffs and restrictions on imports. Very few
items were permitted to be freely imported. Additionally, high customs duties were imposed to
discourage imports and to protect the domestic industry. Tariffs and quotas are not popular
internationally as they tend to close markets. When India lifted its barriers, several industries such as
the mini steel and the scrap metal industries collapsed (imported scrap became cheaper than the
domestic one). Quotas are not restricted to developing countries. The United States imposes quotas on
readymade garments and Japan has severe quotas on non-Japanese goods.
 Exchange Control : The purpose of exchange control is to manage the supply and demand
balance of the home currency by the government using direct controls basically to protect it. Currency
control is the restriction of using or availing of foreign currency at home/abroad.
In India, up to liberalization in the nineties there was very severe exchange control. Access to foreign
currency was tightly controlled and the same was released only for permitted purposes. This was
because Indian exports had not taken off and there were still large imports. There are several countries
that maintain their rates at artificial levels such as Bangladesh.
India is now fully, convertible on the current account but not as yet on the capital account. This, to an
extent, possibly saved India when the run on currencies took place in Asia in 1997. If the Indian rupee
was fully convertible and there were no exchange control restrictions, the rupee would have been open
for speculation. There would have been large outflows at a time of concern resulting in a snowballing
plunge in its value.
As long as the par value system prevailed, the rates could not go beyond the upper and lower intervention
points. The only real question under the fixed rate system was whether the balance of payments and
foreign exchange reserves had deteriorated to such an extent that devaluation was imminent or possible.
Countries with strong balance of payments and reserve positions were hardly called upon to revalue their
currencies. Hence, a watch had to be kept only on deficit countries. However, under generalized floating
regime, exchange rates are influenced by a multitude of economic, financial, political and psychological
factors. But the relative significance of any of these factors can vary from time to time making it difficult to
predict precisely how any single factor will influence the rates and by how much.

FOREX

A Foreign exchange market or Forex market is a market in which currencies are bought and sold. It is to
be distinguished from a financial market where currencies are borrowed and lent.
General Features of Forex Market
Foreign exchange market is described as an OTC (Over the counter) market as there is no physical place
where the participants meet to execute their deals. It is more an informal arrangement among the banks
and brokers operating in a financing centre purchasing and selling currencies, connected to each other by
tele communications like telex, telephone and a satellite communication network, SWIFT(Society for
Worldwide Interbank Financial Telecommunication). The term foreign exchange market is used to refer to
the wholesale a segment of the market, where the dealings take place among the banks. The retail
segment refers to the dealings take place between banks and their customers. The retail segment refers
to the dealings take place between banks and their customers. The retail segment is situated at a large
number of places. They can be considered not as foreign exchange markets, but as the counters of such
markets. The leading foreign exchange market in India is Mumbai, Calcutta, Chennai and Delhi is other
centre’s accounting for bulk of the exchange dealings in India. The policy of Reserve Bank has been to
decentralize exchages operations and develop broader based exchange markets. As a result of the
efforts of Reserve Bank Cochin, Bangalore, Ahmadabad and Goa have emerged as new centre of foreign
exchange market.
Size of the Market
Foreign exchange market is the largest financial market with a daily turnover of over USD 2 trillion.
Foreign exchange markets were primarily developed to facilitate settlement of debts arising out of
international trade. But these markets have developed on their own so much so that a turnover of about 3
days in the foreign exchange market is equivalent to the magnitude of world trade in goods and services.
The largest foreign exchange market is London followed by New York, Tokyo, Zurich and Frankfurt.
The business in foreign exchange markets in India has shown a steady increase as a consequence of
increase in the volume of foreign trade of the country, improvement in the communications systems and
greater access to the international exchange markets. Still the volume of transactions in these markets
amounting to about USD 2 billion per day does not compete favorably with any well developed foreign
exchange market of international repute. The reasons are not far to seek. Rupee is not an internationally
traded currency and is not in great demand. Much of the external trade of the country is designated in
leading currencies of the world, Viz., US dollar, pound sterling, Euro, Japanese yen and Swiss franc.
Incidentally, these are the currencies that are traded actively in the foreign exchange market in India.
24 Hours Market
The markets are situated throughout the different time zones of the globe in such a way that when one
market is closing the other is beginning its operations. Thus at any point of time one market or the other is
open. Therefore, it is stated that foreign exchange market is functioning throughout 24 hours of the day.
However, a specific market will function only during the business hours. Some of the banks having
international network and having centralized control of funds management may keep their foreign
exchange department in the key centre open throughout to keep up with developments at other centers
during their normal working hours. In India, the market is open for the time the banks are open for their
regular banking business. No transactions take place on Saturdays.
Efficiency
Developments in communication have largely contributed to the efficiency of the market. The participants
keep abreast of current happenings by access to such services like Dow Jones Telerate and Teuter. Any
significant development in any market is almost instantaneously received by the other market situated at
a far off place and thus has global impact. This makes the foreign exchange market very efficient as if the
functioning under one roof.
Currencies Traded in Forex Markets
In most markets, US dollar is the vehicle currency, Viz., the currency used to denominate international
transactions. This is despite the fact that with currencies like Euro and Yen gaining larger share, the share
of US dollar in the total turn over is shrinking.
Physical Markets
In few centers like Paris and Brussels, foreign exchange business takes place at a fixed place, such as
the local stock exchange buildings. At these physical markets, the banks meet and in the presence of the
representative of the central bank and on the basis of bargains, fix rates for a number of major currencies.
This practice is called fixing. The rates thus fixed are used to execute customer orders previously placed
with the banks. An advantage claimed for this procedure is that exchange rate for commercial
transactions will be market determined, not influenced by any one bank. However, it is observed that the
large banks attending such meetings with large commercial orders backing up, tend to influence the rates.