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How to Minimise Export Risks

Date: January 20, 2010 Author: Dr. Amit K Chatterjee

Export is considered a high-risk high-return business by many. Transacting business with an overseas partner thousands of miles away is a daunting factor for many. As a result, majority of SMEs are happy to supply locally and stay away from export.

SMEs in India contribute 40% to the total exports directly and a significant amount of exports indirectly through large trading houses or third parties. However, in spite of their sizeable contribution to exports, less than 0.5% of SMEs are actually engaged in exports. 

Whar Are The Perceived Risk Factors  ?

Assurance of timely payment and lack of risk mitigating avenues are considered major factors for such reluctance. The issue was studied in detail under the project ‘Strategies and Preparedness for Trade and Globalisation in India’, a ministry of commerce, Unctad and DFID initiative. The study suggested that SMEs may take the following steps to manage their payment risks and take remedial measures if bad debt does occur.

Know Your Buyer

The first step in the management of export payment risk is to get a credit rating report of your buyer. There are many agencies in India that provide credit rating reports on companies internationally. There are also companies which specialise on specific countries. Further, an SME can also approach its bank to secure a report on the buyer through its banking channels. Similarly, insurance companies help their customers getting credit reports.

However, a credit rating report can not guarantee against payment default and at best is an added comfort. Moreover, credit report report on companies outside USA and Europe are not always available or are as reliable.

Typically, a credit rating report costs $ 100 to $ 150. Delivery time is usually 7-10 days, faster the delivery, higher is the cost. Dun and Bradstreet, Mira Inform are some of the agencies SMEs can approach.

Credit Insurance

The next step is getting insurance for exports. In simple terms, the purpose of export credit insurance is to insure against the payment default. ‘Trade credit insurance’ or ‘credit insurance’ is an insurance policy and a risk management product offered by export credit agencies (ECAs) to business entities wishing to protect their balance sheet asset accounts receivable from loss due to credit risks such as protracted default, insolvency andbankruptcy.

The export credit insurance market in India is dominated by Export Credit Guarantee Corporation (ECGC). Having been a monopoly until recently, it is believed to have 80-90% marketshare. After deregulation of the insurance sector, all three biggest global credit insurance companies—Euler Hermes, Atradius and Coface—have consolidated their presence in India as re-insurers. Major players in the credit insurance market in India include ECGC, Bajaj Allianz, ICICI Lombard, Iffco-Tokio, New India Assurance and Tata AIG. The insurance cost varies from policy to policy and tend to cost between 0.3% and 1.0% of annual turnover, depending on previous bad debt history and current debt management practices.

Indian SMEs should take a note that most of the credit insuring companies in India do not cover risks such as commercial disputes; causes inherent in the nature of goods; buyer’s failure to obtain import licence; insolvency/default of agents like banks (other than the stock holding agent); risks covered by other general insurers like transit loss; exchange rate fluctuations for short term; failure of exporter to fulfil terms of contract, etc.

Debt Collection

In spite of best precautions - bad debt is an eventuality for which businesses need to prepare for. In such situations, professional assistance from debt collection agencies (DCAs) could be considered. Most collection agencies operate as agents of creditors and collect debts for a fee or percentage of the total amount owed. Some agencies, often referred to as ‘debt buyers’, purchase debts from creditors for a fraction of the debt’s value and pursue the debtor for the full balance.

Debt collection agencies in India have struck alliances across the world. When an SME approaches an agency for debt collection and provides details of bad debts, the agency quotes its success commission against recovery. The collection agency makes money only if it is collected from the debtor (often known as a ‘no collection, no fee’ basis). The agency takes a percentage of the debt that is successfully collected, sometimes known in the industry as the ‘pot fee’, or potential fee, upon successful collection. This does not necessarily have to be upon collection of the full balance and very often this fee is paid by the creditor if they cancel collection efforts before the debt is collected.

A contingent fee structure (‘no collection, no fee’) is pretty much the standard for collections around the world. Depending on the type of debt, the fee ranges from 10% to 50% (though more typically. the fee is 15-35%) plus the advanced upfront cost that is adjusted towards success fee. In case of litigation, the fee would go higher. Some agencies offer a flat fee, called ‘pre-collection’ or ‘soft collection’ service. Historically, fee is based on the size of the account, the amount collected and the type of handling (whether in-house or through a lawyer or lawsuit). However, other factors that may be used to set rates include the age of the account at placement, location of the debtor, strength of the case.

There are agencies operating in India as well as country-expertise agencies. The study suggested that SMEs should be careful when choosing debt collection agencies and should take into account the firm’s reputation, its customer base (one should select an agency that specialises in collecting from the category of customer the SME serves); size (an agency too big might not accord enough attention to small debts and a very small one might not be worth risking the collection if the amount is big); and its legal and financial position.

One should check as to how the agency proposes to pay the money once it is collected. An agency that maintains ‘trust accounts’ should be preferred. A trust account is a separate account where money from collections is held until remitted to the SME.

The study, published by FISME in a handbook form, enlists nine India-based buyer credit report providers and 21 country-specific ones. It also provides contact details of 13 debt collection agencies (operating in India) and around 400 agencies operating globally.

Source: Based on Article by Mr. Anil Bhardwaj, secretary general, Federation of Indian Micro, Small & Medium Enterprises (FISME) published in Financial Express

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