Global Countertrade

RUNNING HEAD: Global Financing and Exchange Rate Mechanisms

Global Financing and Exchange Rate Mechanisms-Countertrade

Alyson Anderson

University of Phoenix Online

MGT 448/Global Business Strategies

Dr. Richard Dool

October 15, 2006

In pre-monetary societies, the most logical way of managing the material needs of a community was to distribute goods by bartering among the members according to need and surplus production. For example, if one family or group grew corn but another raised sheep, items could be traded between the groups as needed. This method was cumbersome, time-consuming, and could prove to be inequitable given the disparate nature of the items traded. The solution for this was the production of money, which basically leveled the playing field and gave every item an intrinsic value for purposes of trade. For local trading, this proved to be an excellent system with few drawbacks.

From a global trade standpoint there have proven to be some inherent problems in the basic system of providing currency for goods and services. As there is not a global currency with the same value for all players, exchanging the local currencies at a fair rate has proven to be difficult. In addition, many countries simply do not have the financial wherewithal to back up the value of their currency, making this system impossible to sustain at times.

One solution to this has proven to be a system similar to the ancient use of bartering; that of engaging in countertrade. Countertrade is basically a system of trade, including bartering, when goods or services are accepted in lieu of payment in currency for the purchase of goods or services. (FDIC, 2006) Reasons for choosing countertrade are numerous, but fall primarily into these areas:

* Financial - some people or countries simply cannot pay in the currency necessary to complete a desired transaction. This can be due to having a non-convertible currency, a lack of commercial credit or a shortage of foreign exchange experience or ability. Countertrade may also be a useful where foreign exchange is limited or unavailable.

* Political - A country can be in political crisis, lack the political infrastructure to manage currency trade, or have legal issues which prevent free financial transaction. The IMF and World Bank have become increasingly restrictive in the way they allow governments to operate, making countertrade a viable alternative for many developing countries.

* Expansion - Countertrade is often viewed as an excellent mechanism to gain entry into new markets. The party receiving the goods may become a new distributor, opening up new international marketing channels and ultimately expanding the market. (Richardson, 2005)

Other reasons for countertrade include the need to work around other liquidity issues besides the ones already mentioned, to repatriate blocked funds, to clean up bad debt situations, to build and enhance customer relationships for future sales, to keep from losing markets to other global or local competitors, and to find lower-cost purchasing sources for the needs of the organization. Within these reasons, different types of countertrade exist for different purposes and situations: barter, offset, (both direct and indirect), counterpurchase, tolling, buyback, and switch trading are the most common forms of countertrade.

Barter is the oldest form of countertrade and involves the direct transfer of goods or services between parties. These goods are of equal or offsetting value, and there is no cash involved. One of the major drawbacks to bartering is the considerable risk involved, as one party usually waits to ship its goods until the other party has done so. One way to mitigate this risk is to prepare letters guaranteeing performance by both parties, which allows for legal action to take place to enforce the agreement.

Offset countertrade is best understood in its most commonly used context; that of military trading for the purpose of making major purchases of military goods. Direct offset has been particularly common for trade in defense systems and aircraft, and occurs when a supplier agrees to incorporate materials, components or sub-assemblies procured from the importing country. In some large contracts, bidders may be required to establish local production as a contingency of the bid's acceptance.

Indirect offset occurs when a purchaser requires a supplier or suppliers to enter into long-term industrial co-operation and investment, but these are not tied to the supply contract.

"The overall objective of offset either, direct or indirect, in the defence sector generally to promote import substitution and to minimise the balance of payments deficit for military purchases by developing an indigenous industrial defence capability."

(Richardson, 2006)

The next form of countertrade is the one most commonly used; that of counterpurchase. Counterpurchase is an exchange of goods occurs between two parties that use two contracts in an agreement to supply goods or services to each other and to purchase all goods in cash. The first contract is the original sales contract, outlining the terms in which an initial buyer purchases from an initial seller. The second contract outlines the terms in which the original seller agrees to buy unrelated goods from the original buyer. (Farlex, 2006)

For example, a country wishing to purchase coffee from another can pay for that coffee with a shipment of grain in a set of contracted transactions which are basically separate from one another. These transactions form an agreement for one country to purchase a defined number of goods over a set period as payment for goods received from the other country. There are often third party suppliers involved in these contracts, and they can get very complicated. This system is a useful one; it allows the movement of needed goods in a more equalized manner as well as being strictly controlled via the signed agreements.

Another form of countertrade is tolling, which occurs when manufacturing is contracted to an overseas country, but the raw materials are supplied and the value is added before finished or partially-finished products are returned to the supplier. The original supplier sets parameters for design, product specifications, and market requirements, and will often give technical assistance during the manufacturing process.

Buyback in countertrade means that a company has