Innovative financing to achieve garment export target

February 13, 2017

The government has set a target for the garment industry to reach $50bn of annual exports by 2021, the 50th anniversary of the founding of the nation. This is a demanding target requiring $20bn of annual volumes to be added.

Every RMG export transaction implies (approximately) a six-month working capital requirement. This is typically the time period between the initial purchase order by exporter and the sale of garments for cash in the retail shop of the buyer. The growth target of US$20bn per annum implies an incremental working capital requirement of around US$10bn.The additional investment in land, building and machinery are much higher. The present local and foreign currency may not be sufficient to support such huge transactions. The buyers are increasingly reluctant to provide funding to their suppliers - preferring to work with deferred payment and open account (so they can sell the garments before they pay for them). This means that the working capital requirement has to be met in the exporting country.

Achieving this will require a combination of measures, including (a) the cash resources already available to the various importers and exporters, (b) large amounts of available banking lines (domestically/internationally), and (c) the involvement of independent third parties (such as import and export factors and trade finance companies).

Some advanced financial products have recently been introduced in the global financial market to solve the problem of shortage of working capital for both buyers and sellers. These products are: International Trade Finance (ITF) and Factoring. These are identical products and successfully serve the purposes of the buyers and sellers. One of the easiest and cheapest ways for suppliers to find working capital is to work with an international trade finance company (ITFC) and Factoring companies.

The current trend in garment export is to avoid Letter of Credit (Lc) and against export contract between exporters and importers. The contract sale is also called open account transaction. It is a standard practice of deferred payment. The payment against a contract with deferred payment may create a vulnerable situation for garment exporters because of possible risks of stock lot (refusal by buyer), discount to accept the consignment and even non-payment.

A garment factory and a buyer agree on their purchase order, perhaps with 90 days deferred payment after the shipment date, and on open account. This is what buyers typically demand today for incremental orders; 90 days deferral allows them to pay for the goods after selling them.

The International Trade Finance Companies (ITFCs) has come up with a good solution. Upon agreement with the garment factory, an ITFC arranges a sight payment guarantee (which can be drawn on it, or can be in the form of a sight LC from overseas bankers). The buyer is not involved in this process.

Once the goods are shipped, the ITFC purchases the invoice at sight of the documents, paying at least 95 per cent in cash. It takes the responsibility for collecting from the buyer on the due date of the invoice at its risk. This arrangement secures the payment for exporter and their bankers.

The ITFC may also have another contract with buyers to arrange deferred payment against contract with exporters. ITF products are based upon Direct Import Factoring but also include (and are integrated with) additional services, such as arranging sight letters of credit in favour of exporters upon request of the exporter, managing currency risks (where purchase orders are not in USD), and documentary collections.

KEY FEATURES OF ITF SERVICES: The buyer and factory both get what they need, without changing their operational procedures. There is no credit risk on seller, because ITFC pays in cash at sight at least 95 per cent of the invoice face value to the factory. ITF service is in full compliance with both the form and substance of Foreign Exchange Regulations. The income and services provided by local banks in support of the factory are unchanged.

 

ITF is very close to International Factoring, a similar trade finance mechanism. The Factoring involves contract between buyer and a local Factoring company and another contract between seller and local Factoring company. These two contracts are supported by two factoring companies in exporter's and importer's countries. The method of Factoring involve: (1) the exporter ships the goods to his importer, (2) the exporter assigns his invoices to the import factor, who assumes the credit risk, provided this has been agreed to beforehand, (3) the import factor handles the accounts receivable in accordance with the sales contract between the exporter and the importer, (4) the importer pays the import factor on the due date, and (5) the import factor forwards the payment to the exporter, possibly deducting the agent's commission.

ITFCs perfectly bridge the gap between what the supplier needs and what the buyer prefers to offer. It is a unique finance product to meet the requirement of exporters and bankers in Bangladesh under Foreign Exchange Regulation Act, 1947 and undertake the risk of payment of buyers.

At present a British company PrimaDollar Operations Ltd and a German company DS Concept are active with two financial products - Factoring and ITF in Bangladesh. Both of these two companies have their liaison offices in the country.

Introduction of Factoring requires policy support and specific regulations which are yet to be formulated by the Government.

Source: The Financial Express