It provides the exporters with working capital between the time of the receipt of order and the time of shipment to arrange for production or procurement of goods. Pre-shipment finance is of particular importance to small scale manufacturers and exporters who do not possess sufficient financial resources to meet the expenditure involved in the production of goods for export.
Pre shipment finance is normally provided by the commercial banks. As in the case of many other advances the bank takes into consideration a number of factors before making the necessary other advances to exporters viz., (1) honesty, integrity and capital of the borrower, (2) exporter’s experience in the line, (3) security offered, (4) the margin of interest (5) the bank’s experience about the exporter to ensure that his name does not appear on the caution list of the Reserve Bank.
The security can be provided in the following forms:
1. Letter of credit
2. Confirmed order as evidence of having received an order
3. Relevant policy issued by the Export Credit Guarantee Corporation and
4. Personal bond in the case of party(ies) already known to the banker
Very often manufacturers might have to supply goods to an export house in such cases manufactures may obtain pre-shipment finance on the basis of a letter from the export house containing (i) the obligation of the supplier and (ii) a certificate that it is not itself claiming the pre shipment credit.
Pre-shipment finance would normally cover the following costs:
(i) cost of purchase or production
(ii) packing including any special packing for export
(iii) costs of special inspection or tests required by the importer
(iv) internal transport costs
(v) port, customs and shipping agents charges
(vi) freight and insurance charges if the contract is either c&f contract or a c.i.f contract and
(vii) export duty to tax if any
In certain cases the pre-shipment advance is made to finance expected receivables such as drawbacks. Where domestic production costs are higher pre shipment finance may be higher than the f.o.b value of the contract to adequately cover the higher domestic costs. Pre-shipment advance may take the form of loan overdraft or cash credit.
The concessional rate of interest on pre- shipment finance is PLR – 2.5 percent up to 180 days and beyond 180 days as up to 270 days, Interest is PLR + 0.5 per cent. Banks are free to charge any interest beyond 270 days.
PLR (Prime lending rate) varies between 11-12 per cent.
Pre-shipment Credit in Foreign Exchange: With a view to make export credit available at internationally competitive rates, banks have been allowed to extend Pre-shipment Credit in Foreign Currency (PCFC) at rates linked to LIBOR (London Inter-bank Offer Rates). This facility is available in all convertible currencies. Pre-shipment credit is available for 180 days at 0.75 per cent above six-months LIBOR. If beyond 180 days, then the rate would be 2.75 per cent over LIBOR prevailing at the time of extension. The credit would be self-liquidating in nature and will be adjusted by discounting the related export bill designated in foreign currency.
Banks will be using funds available with them such as Exchange Earners’ Foreign Currency and Foreign Currency Non-residents Accounts. They can also borrow abroad so long as the cost of borrowing does not exceed 1 per cent over LIBOR.
For the exporters, there are two specific advantages: lower rate of interest and saving of conversion charges if credit is utilized to purchase imported inputs.
If an exporter is well known to the banker and his past performance has been satisfactory, the banks are usually prepared to grant revolving pre-shipment credit in connection with successive deliveries. This implies that upon repayment of the first loan, the exporter is automatically granted a corresponding loan on the same terms. This procedure offers the advantage of saving time and costs as the original documents serve as a basis for extended credit.
Packing credit is adjusted out of the post-shipment facility provided by the banks. Pre-shipment credit may also be provided under a letter of credit with a red clause where advance is granted at the instance and, therefore, on the responsibility of the foreign bank establishing the credit.
In case the goods are to be procured or purchased from a supplier or a manufacturer, the banks may open a letter of credit in favor of the suppliers under what is known as ‘back to back letter of credit’. This procedure is usually adopted by export houses for getting letters of credit in favor of their suppliers. In such cases credit can be extinguished by drawing a bill on the export house.
In the case of consignment sales, banks usually establish a special post-shipment credit account which is adjusted when the goods are sold abroad and the sale proceeds received.