27

International Finance
Introduction
Objectives
 To get perspective of international finance and Financial Institutions
 To understand international project evaluation dynamics
 To be familiar with various international financing options available to the industry
Perspective
Since Independence in 1947, India had consistently followed an inward looking strategy
wherein we wanted to achieve self sufficiency in practically all aspects. The presumption of
the powers- that- be was that given the size of Indian population, poverty and other socio-
economic issues faced by the country, we would like to create all resources within so that our
dependence on foreign countries was minimal. However, this inward looking policy faced a
major challenge in early 1990s’ when India had to pledge its gold reserves to meet its
commitment of payment to foreign lenders. Given this scenario, India had no option but to
open its frontiers for integration of its economy with the world economy. Whilst India is
gradually putting her house in order, we are periodically faced with major financial challenges
in the form of Asian currency crisis, Europe meltdown, Quantitative easing, and subprime
crisis etc. etc. making it virtually unavoidable for the Indian Industry to get a better perspective
of the issues involved in this global integration and be prepared to face it with increased
confidence. This module is a step in that direction.

Role of International Financial Markets

Financial markets in the broad sense of the term can be understood as platforms that enable
the trade of various financial instruments such as equities, derivatives, currencies etc. Trade
takes place on the basis of prices determined by market forces of demand and supply. To
become more specific, financial markets serve the primary purpose of raising short- term as
well as long- term finances.
International financial markets function in much the same manner. They facilitate the
transference of purchasing powers from investors to borrowers and other parties interested in
the acquisition of such assets as are forecasted to yield benefits. The fundamental difference
between domestic and international markets is that the transactions taking place in
international markets involve entities residing in varied financial hubs that cross national
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borders. Due to their transnational nature, they link the domestic financial markets in different
economies, operating as autonomous systems outside local jurisdictional limits. As these
financial centers cross jurisdictional limits and are autonomous in their functioning as such,
they are also characterized as intermediaries that facilitate the movement of savings to their
optimal use without the constraints of their place of origin as well as use.
International Financial Markets overcome some of the biggest issues with international trade
in the form of tariff barriers and domestic commercial policies. They create a unique
opportunity for investors in several areas that are developing but are geographically remote.
The incentives for utilizing international financial markets include:
 Favorable economic conditions in assorted financial centers across the globe that
provide better investment opportunities to foreign investors
 Global currency trends wherein investors expect foreign currency rates to appreciate
with respect to their domestic currency
 To take advantage of increasing or decreasing interest rates on foreign currency as the
case may be
Some of the main functions of these markets are as follows:
1. Price Discovery Process: The phenomenon of price determination on the basis of
volume traded in the market dependent on demand and supply
2. Liquidity: Financial markets facilitate liquidity of financial resources in the market
through continuous trade of financial assets
3. Cost Reduction: Financial Markets play a crucial role in the reduction of transaction
costs and ensure dissemination of information at minimal costs

International Capital Budgeting

Any and all business ventures or investments in general are undertaken with the purpose of
earning profit. A successful venture is one where the return that is received after a specific
term has lapsed, is significantly more than the resources poured at the initiation of such
venture. This is the basis of maximizing shareholders’ wealth. Capital budgeting (or
investment appraisal) is the planning process used to determine whether a firm's long term
investments, such as new machinery, replacement machinery, new plants, new products and
research development projects, are worth pursuing. It is budgeting for major capital,
investment or expenditures . (Wikipedia. 2008: 213). Here, capital refers to resources that
are invested in capital assets while budgeting refers to the detailed financial analysis of cash
flows pertaining to any proposed capital project, over a determined time period.
Creation of shareholder wealth is attributed to returns made on investments, in the context of
present value of money. In the light of this, one of the most critical decisions facing a financial
manager is the selection of projects to invest in. As the capital is essentially scarce, it is all the
more important for the manager to ensure that the resources are optimally utilized.
 International Finance 26.3

In modern finance, the most accepted and implemented method for capital budgeting are
based on
(a) Non - Discounted Cash Flow Basis: Here the present and future cash inflows and
outflows are not discounted and it is assumed that an amount received / spent today is
the same as the one received / spent in future. The important form of evaluation under
this method are:
(i) Accounting Rate of Return
(ii) Pay Back Period
(b) Discounted Cash Flow Basis: Here the amount received / spent in future is brought to
the current period by suitably discounting it and using discount factors like Weighted
Average Cost of Capital (WACC). The important form of evaluation under this form are:
(i) Net Present Value Method(NPV)
(ii) Internal Rate of Return (IRR)
(iii) Adjusted Rate of Return
(iv) Profitability Index
While the basic framework of evaluation of capital projects in domestic and international
capital budgeting is similar, there are a few important areas where the differences exist. These
important differences arise due to the existence of two entities as part of the project, namely,
Parent (usually a transnational company) and the Subsidiary (usually a joint venture or wholly
owned company) in other country in which the project is implemented. The differences are as
follows:
(a) The Parent cash flows are distinguished from project cash flows. This is due to the
existence of a number of fund transfers / remittances between the parent and the
subsidiary in the form of:
(i) Parent usually sells key raw material to the subsidiary at a marked up price
leading to incremental profits to the parent
(ii) Royalty payment by the subsidiary to the parent
(iii) One-time technology fee paid by the subsidiary to the parent
(iv) Fee paid for the technicians who represent the parent in the subsidiary and help
in implementation of the project
(b) Parent cash flows often depend on the form of financing thus cannot clearly separate
cash flows from financing
(c) Exchange rate movement of the currency of two entities
(d) Different inflation rates in the two countries
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(e) Different tax structure of the two entities in two countries

(f) Different cost of capital and risk premium of the two entities due to diverse political risk
(g) Difficulty in estimating terminal value due to different perception and divergent views
The evaluation process entails making cash flow statement of both parent and subsidiary
(project) and the project is accepted for investment if it is viable for both the parent and the
subsidiary. If; due to above-mentioned factors, the project becomes viable for the parent but
is unviable for the subsidiary, then either the project is shelved or terms of engagement are re-
negotiated between the two parties.

Regulation Related to FDI and ECB:

Investment

Long Term Short Term

Equity
Borrowings Borrowings

Foreign Exchange
FDI Debentures Management
(Borrowing or Lending
in Foreign Exchange)
Regulations, 2000
Convertible
Preference Shares

ECBs

Convertible
Debentures

Unfunded Loans
 International Finance 26.5

Foreign Direct Investment (FDI):

FDI refers to Foreign Direct Investment. Foreign investment in India is regulated by: (i) the
industrial policy; (ii) FEMA and the rules promulgated there- under; (iii) the regulations and
notifications issued by the Reserve Bank; and (iv) the FDI Policy issued by the DIPP. The
FIPB, a department of the Ministry of Finance, is the regulatory body responsible for regulating
foreign investment in accordance with the Industrial Policy. In addition, the Reserve Bank also
regulates foreign investment for the purposes of exchange control in accordance with the
provisions of the FEMA.
In India, the treatment accorded to each of the instruments with respect to investments made
by any foreign investor is different under the current FDI Policy.
1. As per the FDI Policy, a foreign investor can invest in equity shares- fully, compulsorily
and mandatorily convertible preference shares, fully, compulsorily and mandatorily
convertible debentures Further, the price/ conversion formula of convertible instruments
should be determined upfront at the time of issue of the instruments.
2. Investment in warrants and partly-paid shares will require prior approval under the
Approval Route.
3. Issuance of preference shares which are non-convertible, optionally convertible or
partially convertible would be subject to compliance with extant regulations pertaining to
ECB.
FDI is prohibited in the following sectors:
(a) Lottery business including Government /private lottery, online lotteries, etc.
(b) Gambling and betting including casinos, etc.
(c) Chit funds;
(d) Nidhi company;
(e) Trading in transferable development rights;
(f) Real estate business or construction of farm houses;
(g) Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco
substitutes; and
(h) Activities / sectors not open to private sector investment atomic energy and railway
transport (other than mass rapid transport systems).
Additionally, other than specified agriculture related activities, FDI is not permitted in
Agriculture sector/activity
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FDI in India can be done through the following modes:

Issuance of fresh shares by a company: Subject to compliance with the FDI Policy and FEMA,
an Indian company may issue permissible instruments under the FDI Policy to a non-resident
investor.
Acquisition by way of transfer of existing shares: Non- resident investors can also invest in
Indian companies by purchasing/acquiring existing instruments permissible under the FDI
Policy from Indian shareholders or from other non-resident shareholders in the following
manner:
(a) Non-resident to Non-resident: A person resident outside India (other than an NRI or
OCB) can transfer, by way of sale or gift, the shares or convertible debentures of an
Indian company to any person resident outside India.
(b) Resident to Non-resident: A person resident in India can transfer, by way of sale,
permissible instruments under private arrangement to a person resident outside India,
subject to compliance with the sectoral caps, pricing guidelines, reporting requirements,
etc. Gift of such instruments by a resident to a person resident outside India will require
the prior approval of the Reserve Bank.
(c) Non-resident on the Stock Exchange: A person resident outside India can sell the
shares and convertible debentures on a recognized stock exchange in India through a
stock broker registered with stock exchange or a merchant banker registered with SEBI.
Only FIIs/FPIs and NRIs (under the Portfolio Investment Scheme) or Qualified Foreign
Investors are permitted to invest/trade in the shares of an Indian company on the stock
exchange through a registered broker.
Further, a non resident investor who has already acquired and continues to hold the control in
accordance with SEBI Takeover Regulations can acquire shares of a listed Indian company on
the stock exchange through a registered broker under FDI scheme, subject to the FDI scheme
and FEMA regulations in respect of sector cap, entry route, mode of payment, reporting
requirement, documentation, etc.
Additionally, it is permitted for Non-resident investor to have FDI in registered LLPs by
contribution to the capital or by acquisition or transfer of share of profit of the LLP, subject to
approval under the government route, and in compliance with the scheme for FDI in LLP.
Percentage of Foreign Holding
Depending upon the nature of industry, the percentage of FDI holding in industry in India can
be 100%, 74%, 49% or 26%.

External Credit Borrowings (ECBs):

ECB refers to External Capital Borrowings. ECBs are sources of finance and funds available
to corporations, originating out of India. Such borrowings are preferable due to the relatively
 International Finance 26.7

lower cost of finance arising from economic conditions prevalent in international financial
markets. The three decisive factors favouring ECBs are:
 The significantly lower interest rates in international financial markets
 The maturity period is longer
 It can be channelled into financing for expansion goals as well as fresh investment
Foreign investment in partially or optionally or non-convertible preference shares/bonds/
debentures, is construed as an ECB and would be subject to the ECB norms. At present ECB
is governed by the Master Circular on External Commercial Borrowings and Trade Credits
issued by the Reserve Bank on July 1, 2013. The Master Circular consolidates all the existing
instructions on the subject of ‗External Commercial Borrowings and Trade Credits’ in one
place and is updated on a year- o-n year basis in intervening circulars.
As per the Master Circular, ECBs may be accessed under two routes: (a) automatic route; and
(b) approval route. If any of the prescribed conditions are not complied with, the automatic
route is not available, and prior approval of the Reserve Bank is required for the ECB under
the approval route.
Corporates, including those in the hotel, hospital, software sectors (registered under the
Companies Act) and infrastructure finance companies except financial intermediaries, such as
banks, financial institutions, housing finance companies and NBFCs , NGOs and SEZs are
eligible to raise ECB under the automatic route. On July 8, 2013, the RBI permitted NBFCs
categorized as Asset Finance Companies to avail of ECB under the automatic subject to
certain conditions stipulated in the guidelines.
These borrowers can raise ECB from internationally recognized sources such as (i)
international banks, (ii) international capital markets, (iii) multilateral financial institutions (such
as IFC, ADB, CDC, etc.) / regional financial institutions and Government owned development
financial institutions, (iv) export credit agencies, (v) suppliers of equipment, (vi) foreign
collaborators and (vii) foreign equity holders (other than erstwhile OCBs).
An ECB, irrespective of whether it is obtained through the automatic or approval route, cannot
be obtained at a cost that exceeds the all-in-cost ceilings prescribed by the Reserve Bank.
This ceiling includes the rate of interest, other fees and expenses in foreign currency (except
commitment fee), pre-payment fee and fees payable in Indian Rupees. These ceilings are
reviewed from time to time, and presently stand at 350 (three hundred and fifty) basis points
over the six (6) month LIBOR for ECBs with an average maturity period of between 3 (three)
and five (5) years, and 500 (five hundred) basis points over the six (6) month LIBOR for ECBs
with an average maturity period of more than five (5) years.
The Reserve Bank prescribes minimum average maturity periods over which the borrower
must repay the facility. Depending on the value of the facility, the minimum average maturity
ranges from three (3) to five (5) years. ECBs of a shorter maturity period require the prior
27.8 MBF Study Module

approval of the Reserve Bank. An ECB cannot be refinanced or prepaid before the expiry of
the minimum average maturity period applicable to it.
The Master Circular also specifies end-use restrictions on the amounts received as an ECB.
The permitted uses include, inter alia, the import of capital goods (as classified by the
Directorate General of Foreign Trade in the Foreign Trade Policy), payment for acquisition of
3G and 2G spectrum, acquisition of shares in the disinvestment process by the Government,
ODI in JVs / WOS and the implementation of new projects and modernization/expansion of
existing production units in the real sector – industrial sector including small and medium
enterprises, infrastructure sector and specific service sectors, namely hotel, hospital and
software in India.
ECBs are not permitted to be raised for (i) on-lending or investment in capital markets or
acquiring a company (or a part thereof) in India by a corporate; or (ii) use in real estate (as
defined and qualified by the ECB Guidelines); or (iii) working capital, general corporate
purposes and repayment of existing Indian rupee loans (except loans taken by infrastructure
companies, whereby these companies can use 25% (twenty five percent) of the ECB proceeds
to pay off their rupee loans).

Packing Credit Limit

The Reserve Bank of India has defined Packing Credit as:
“[Packing Credit] means any loan or advance granted or any other credit provided by a bank to
an exporter for financing the purchase, processing, manufacturing or packing of goods
prior to shipment / working capital expenses towards rendering of services on the basis of
letter of credit opened in his favour or in favour of some other person, by an overseas buyer or
a confirmed and irrevocable order for the export of goods / services from India or any other
evidence of an order for export from India having been placed on the exporter or some other
person, unless lodgment of export orders or letter of credit with the bank has been waived.”
Packing credit or pre-shipment credit is an advance that has been extended by any bank to an
exporter for the purpose of procuring raw materials and processing/manufacturing the goods,
before packaging them for exporting. Packing Credit (PC) is thus a financial facility provided
by a bank to export units. Its duration begins from the stage of purchase order and lasts till the
shipment of products is underway. Packing Credit includes within its ambit of coverage, cost of
all raw materials and various other input factors, manufacturing costs, packaging costs,
storage and warehousing costs, distribution and transportation costs, insurance costs and
export duties among other things.
As a facility, Packing Credit is considered an incomparable asset to exporters, especially
those within the small and medium scale industries. This is because these ventures do not
have the financial ability to afford the expenditure for the entirety of the pre-shipment process.
Credit is given on the basis of a letter of credit that has been issued in favour of the exporter.
On the other hand, Packing Credit is provided on more liberal terms as more often than not
 International Finance 26.9

the nature of such loans is need-based. It follows that they are not dependent on the
availability of adequate security as collateral. PC loans may be extended upon established
correspondence and communication between the exporter and the importer. They
can also be granted on the basis of entitlements of duty drawback which have been certified
by the customs authority on a provisional basis.
The norm for duration of Packing Credit is a maximum period of 270 days based on the
operating cycle of the business seeking credit. Some banks fix credit duration depending on
date of delivery of export orders. For example, in case of any export unit being unable to
complete its export orders within the predetermined time span for a bonafide cause, resulting
in the packing credit to lapse past its due date, the bank can, in its discretion, extend the
period of credit. In these situations the bank is at liberty to charge interest as penalty during
the period of extension. However, the maximum period that can be granted at concessional
rates of interest with respect to pre-shipment credit is 180 days.
Pre-shipment credit can be extended in either INR or in foreign currency.
One other pertinent facet of pre-shipment credit is that all such advances made have to be
liquidated via export proceeds. If not, that particular advance may not be available at
concessional rates of interest. Pre-shipment credit can be settled in a running account manner
or on an order to order manner. Running account manner refers to a scenario wherein all
packing credit availed is catalogued under a single account so that when packing credit is
availed the account is debited and on the discounting of the export document, the account is
credited. Banks also offer revolving credit wherein the repayment of an old outstanding loan
automatically grants the exporter a fresh corresponding loan on the same terms. The core
benefit of this offer is that the exporter doesn’t need to knock on different doors to obtain
financing each time he gets an order.

Packing Credit Foreign Currency Limit and Post Shipment

Finance:
Packing Credit Foreign Currency Limit:
Packing Credit is also offered by banks in foreign currency for domestic as well as imported
raw materials and inputs needed for export oriented manufacturing. The exporter can take
advantage of competitive interest rates available in the international markets. It is provided at
LIBOR/EURO or LIBOR/EURIBOR related rates. However, this facility is available to cash
imports only.
The exporter has the options given below for availing export finance:
 Take pre-shipment credit in rupees and post-shipment credit in wither rupees or by
discounting/rediscounting export bills under Rediscounting of Export Bills Abroad
Scheme (EBR)
27.10 MBF Study Module

 Take pre-shipment credit in foreign currency and discount/rediscount export bills in

foreign currency as per the EBR scheme
 Take pre-shipment credit in rupees and converts the withdrawals into foreign currency
credit as per the discretion of the bank
 It can be extended in any of the convertible currencies such as USD, Pound Sterling,
Japanese Yen, and Euro etc.
 Operation flexibility is granted by giving foreign currency credit in one convertible
currency with respect to an export order which has been invoiced in some other
convertible currency
 The cost and risk of the cross currency transaction is borne by the exporter.
 Banks have the option of extending credit in foreign currency to ACU countries
 Benefit accrues to the exporter once export bills have been realized or discounted
without recourse (i.e., forfaiting).
The period of credit for pre-shipment credit in foreign currency extends to a maximum duration
of 360 days. The providing of credit is subject to the same terms and conditions as those
applicable to packing credit given in rupees. It carries an additional interest cost of 200bps
(basis points) over and above the rate of interest applicable for the initial period of 180 days.
Any subsequent extension will be subject to the terms and conditions at the discretion of the
bank. Should there be no export within the 360 day period, the credit in foreign currency will
be to the T.T (Telex/Telegraphic Transfer) selling rate for the concerned currency.
In the situation the entirety of the credit amount or a part thereof is used to finance domestic
input, banks are at liberty to apply the appropriate spot rate for transactions.
Pre-shipment credit in foreign currency can be liquidated from the proceeds of export
documentation once they have been submitted for discounting/rediscounting as per the EBR
Scheme or by granting foreign currency loans (Documents against Payment (DP) Bills) or from
the balance of the Exchange Earner’s Foreign Currency Account (EEFC A/c) or thirdly from
rupee resources available to the exporter to the extent exports have taken place in actuality.
Post Shipment Finance:
Post-shipment finance or credit refers to advances made by banking institutions to any
exporter from the moment the foods are shipped or exported till such time as the proceeds are
received. Post-shipment credit is provided so that the exporter may be able to meet his
financial needs during the period between shipment of the products and the realization of
proceeds from exports. It includes loans and advances extended to the exporter on the basis
of security of duty drawbacks.
Post-shipment credit is usually provided in the manner of bills discounting or purchasing or as
an advance made against bills that are under collection. For situations wherein the importer
issues a letter of credit in favour of exporter, the exporter is eligible to receive proceeds of
 International Finance 26.11

sales immediately. Whereas, in situations where no letter of credit has been issued, the
banking institution can either purchase or discount the bills of exchange, or it can send them
for collection. Banks also offer post-shipment credit against security of shipping documents
that have been approved like bill of lading or commercial invoice etc.
Credit can be short- term, long- term or medium- term. Medium- term credit is for duration of
up to 5 years, and is provided with regard to durable consumer goods and light capital goods.
Long- term credit is provided for capital goods and the conclusion of turnkey projects. The
time duration for which credit is extended depends on terms and conditions mentioned in the
export bill. It is maintained on a bill- to- bill basis as opposed to a running account.
In many situations, credit limits have not been defined clearly. Thus, total packing credit has
been taken to be a sum of packing as well as post shipment credit. Since, both packing as
well as post shipment credit form components of total credit, each nullifies the effect of the
other. The implication is that in order to draw post shipment credit, there needs to be a
repayment of pre- shipment credit.
Finance other than post shipment credit is also extended at pre-shipment and post-shipment
stage, against export incentives. These include cash subsidies, duty drawbacks, as well as
reimbursements of the difference in indigenous and international pricing of raw materials.
These are provided for under the Export Promotion Scheme started by the Government of
India. Under this scheme, exporters enjoying a high credit rating with established export
credentials are given credit at pre-shipment stage, against export incentives. For all other
applicants, credit is extended at post-shipment stage.

Analysis of Domestic v. Foreign Loan

Ever since the borrowing options, both local and international, have been opened for the
industry and investors in India, there has been a raging debate as to which option is better
than other. The decision to go for domestic vs. foreign loan is dependent upon:
1. Interest rate differential
2. Hedging cost
3. Possibility of Natural Hedge for the borrower
4. Time duration of the loan
Whilst the interest rate on foreign currency denominated loan is usually substantially lower
than the interest rate on rupee denominated loan, the overall cost of foreign currency loan also
includes hedging and service costs. On borrowing foreign currency, the borrower is exposed
to the vagaries of exchange rate movement and runs the risk of paying substantially higher
amount if rupee depreciates against the foreign currency as has been a trend for long. The
service cost includes the information sharing and documentation costs which incidentally is
substantially higher in case of foreign loan than domestic loan. This decision, however, is
different as borrower has natural hedge i.e. the borrower has regular income from service or
27.12 MBF Study Module

exports in the same currency in which it is borrowing. This may incidentally be a cheaper
alternative as the borrower not only saves hedging cost on the borrowed amount but also
saves hedging cost of its export proceeds.
Hence multiple factors need to be evaluated before a correct decision is taken to go for
domestic or foreign loan.

Buyer’s Credit and Supplier’s Credit

Buyer’s Credit
Buyer’s Credit refers to loans for payment of imports into India arranged by the importer from
a bank or financial institutions outside India. Based on letter of undertaking issued by the
importer’s bank, the foreign bank credits the importer’s bank which in turn uses the funds to
make payment to the Supplier’s bank against the import bill.
The benefits of buyer’s credit for an importer are as follow:
 The exporter gets paid on due date whereas importer gets extended date for making an
import payment as per the cash flows.
 The importer can deal with exporter on sight basis, negotiate a better discount and use
the buyer’s credit route to avail financing.
 The funding currency can be in any FCY (USD, GBP, EURO, JPY etc.) depending on
the choice of the customer.
 The importer can use this financing for any form of trade viz. open account, collections,
or LCs.
 The currency of imports can be different from the funding currency, which enables
importers to take a favourable view of a particular currency.
The process for buyer’s credit is as follows:
1. Importer imports the goods either under DC / LC, DA / DP or Direct Documents.
2. Importer requests the Buyer’s Credit Consultant before the due date of the bill to avail
buyer’s credit.
3. Consultant approaches overseas bank for indicative pricing, which is further quoted to
Importer.
4. If pricing is acceptable to importer, overseas bank issues offer letter in the name of the
Importer.
5. Importer approaches his existing bank to get letter of undertaking / comfort (LOU / LOC)
issued in favour of overseas bank via swift.
 International Finance 26.13

6. On receipt of LOU / LOC, Overseas Bank as per instruction provided in LOU, will either
fund existing bank’s Nostro account or pay the supplier’s bank directly (using only
MT202 payment mode).
7. Existing bank to make import bill payment by utilizing the amount credited (if the
borrowing currency is different from the currency of Imports then a cross- currency
contract is utilized to effect the import payment)
8. On due date, existing bank to recover the principal and Interest amount from the
importer and remit the same to Overseas Bank on due date.
The cost involved in buyer’s credit is as follows:
 Interest cost: This is charged by overseas bank as a financing cost. Normally it is
quoted as say “3M L + 350 bps”, where 3M is 3 Month, L is LIBOR, & bps is Basis
Points (A unit that is equal to 1/100th of 1%). To put is simply: 3M L + 3.50%. One
should also check on what tenure LIBOR is used, as depending on tenure LIBOR will
change. For example, as on day, 3- month LIBOR is 0.23560% and 6- Month LIBOR is
0.33350%
 Letter of Comfort / Undertaking: Importer’s Bank will charge this cost for issuing letter
of comfort / Undertaking.
 Forward / Hedging Cost: In some banks, it is mandatory for importers to book for
forwards and some leave the option of deciding on importers.
 Arrangement fee: Charged by Buyer’s Credit Agents / Brokers for arranging buyer’s
credit for importer.
 Other charges: A2 payment on maturity, for 15CA and 15CB on maturity, Intermediary
bank charges etc.
 Withholding Tax (WHT): When funds are arranged from Foreign Bank, Importer has to
pay WHT on the interest amount remitted to the Indian tax authorities.
The documentation required for the application of fresh buyer’s credit is:
 A1 Form (Principal amount)
 ECB Form
 Offer Letter from overseas bank, Letter of Undertaking format & Swift Address
 Import Documents & Bill of Entry (In Case of Direct Documents)
 Request Letter and along with it, authority to debit charges
The documentation required at the time of repaying credit is:
 A2 Form (for Interest payment)
 Form 15CA and Form 15CB (Incase of Foreign Bank)
27.14 MBF Study Module

Regulatory Framework
RBI has issued directions under Sec 10(4) and Sec 11(1) of the Foreign Exchange
Management Act, 1999, stating that authorised dealers may approve proposals received (in
Form ECB) for short-term credit for financing the import of goods into India.
The current norm as per RBI Master Circular on External Commercial Borrowing (ECB)
and Trade Finance 2014 are:
A. Amount and Maturity
 Maximum Amount Per transaction : $20 Million
 Maximum Maturity in case of import of non-capital goods (Raw Material, Consumables,
Accessories, Spares, Components, Parts etc): up to 1 year from the date of shipment
 Maximum Maturity in case of import of capital goods : up to 5 years from the date of
shipment (Beyond 3 years, banks are not allowed to provide Letter of Undertaking /
comfort)
 No Rollover / Extension will be permitted beyond permissible limits
 Trade Credit should be linked to the operating cycle and trade transaction.
B. All-in-cost Ceilings
 Upton 1 year : 6- Month Libor + 350 bps
 Upton 5 years: 6- Month Libor + 350 bps
All applications for short-term credit exceeding $20 million for any import transaction are to be
forwarded to the Chief General Manager, Exchange Control Department, Reserve Bank of
India, Central Office, External commercial Borrowing (ECB) Division, and Mumbai.
Supplier’s Credit
Supplier’s Credit relates to credit for imports into India extended by the overseas suppliers or
financial institutions outside India.
It is required due to the reasons given below:
 Suppliers would ask for sight payment whereas you want credit on the transaction.
 At times, in capital goods, banks would insist on using term loan instead of buyer’s
credit. By this way you can avail cheap LIBOR rate funds, and your supplier would also
not mind as he is getting funds at sight.
The advantages of Supplier’s Credit for the importer are:
 Availability of cheaper funds for import of raw materials and capital goods
 Ease short-term fund pressure as able to get credit
 International Finance 26.15

 Ability to negotiate better price with suppliers

 Able to meet the Suppliers requirement of payment at sight
The advantages for the supplier are:
 Realize at-sight payment
 Avoid the risk of importer’s credit by making settlement with L/C
The flow of the transactional process is as hereunder:
1. With transaction details, importer approaches arranger to get suppliers credit for the
transaction
2. Arranger get an offer from overseas bank on the transaction
3. Import confirms on pricing to overseas bank and gets LC issued from his bank restricted
to overseas bank counters with other required clauses.
4. Supplier ships the goods and submits documents at his bank counter
5. Supplier’s Bank sends the documents to Supplier’s Credit Bank.
6. Supplier’s Credit Bank posts checking documents for discrepancies and sends the
document to importer’s bank for acceptance
7. Importer accepts documents. Importer’s Bank provides acceptance to Supplier’s Credit
Bank LC guaranteeing payment on due date.
8. Supplier’s Credit Bank based on acceptance, discounts the bill and makes payment to
Supplier.
9. On maturity, import makes the payment his bank and importers bank makes payment to
Supplier’s Credit Bank
The cost of the transactions includes:
 Foreign bank interest cost
 Foreign Bank LC Confirmation Cost (Case- to- Case basis)
 Cost for the usance (credit) tenure.
The requirements to apply for supplier’s credit are:
 Import transaction under LC
 Inco terms : FOB/CIF/C&F
 Arrangement has to be done before LC gets opened. In case of LC already opened,
relevant amendment has to be done.
 LC to be restricted to supplier’s credit providing bank under 41D clause of LC
27.16 MBF Study Module

 Under Payment Term: 90 days’ Usance payable- at- sight (mention tenure according to
tenure and offer received)
RBI Regulations
Suppliers’ credit is governed by RBI Circular “Master Circular on External Commercial
Borrowings and Trade Credits” Dated 01-07-2014
A. Amount and Maturity
(a) Maximum Amount Per transaction : $20 Million
(b) Maximum Maturity in case of import of non- capital goods (Raw Material, Consumables,
Accessories, Spares, Components, Parts etc): up to 1 year from the date of shipment
(c) Maximum Maturity in case of import of capital goods : up to 5 years from the date of
shipment (Beyond 3 years, banks are not allowed to provide Letter of Undertaking /
comfort)
(d) No Rollover / Extension will be permitted beyond permissible limits
(e) Trade Credit should be linked to the operating cycle and trade transaction.
B. All-in-cost Ceiling
 Upton 1 year : 6- Month Libor + 350 bps
 Upton 5 years: 6- Month Libor + 350 bps
Difference
Difference between Buyer’s Credit and Supplier’s Credit
 Theoretically speaking, as the name suggests, importer of goods applies for buyer’s
credit and exporter of goods applies for supplier’s credit.
 For all practical purposes, importer applies for buyer’s credit as well as supplier’s credit.
 Supplier’s credit can only be arranged against LC- backed transaction whereas buyer’s
credits can be arranged Sight LC, Usance LC, DA & DP excluding Advance Payment
 Generally Buyer-s Credit quote is arranged for after opening of the LC, whereas
supplier’s credit quote is tied up before opening of the LC. LC is then opened as per the
terms of the funding bank in case of supplier’s credit. However, when the LC is opened
before tying up for the funds in a supplier’s credit, it might need amendment as per the
funding bank.
 Letter of Undertaking (LOU) issuance charges are applicable in case of buyer’s credit,
whereas since supplier’s credit is an LC based transaction, no Letter of Undertaking
(LOU) charges are applicable.
 International Finance 26.17

Forfaiting
Forfaiting is one of the many methods undertaken to finance international trade. It originates
from French, meaning “surrender something” or “relinquishing a right”. With respect to
international trade it is a manner of endorsement wherein the exporter relinquishes right to a
receivable maturing at a future date in exchange for cash payment immediately, made after
adjusting a discount that has been mutually decided. To explain it better, it is the term given to
a transaction wherein the exporter gives up his right to some future receivable in order to
obtain cash payment in the immediate present. The forfaiter, in turn, extends immediate
funding to the exporter while taking responsibility for the claiming of the debt that was due to
the exporter.
Banks hold the corner share in the provision of this facility, for a certain charge on the
transaction.
The following steps are undertaken in the execution of any forfaiting transaction:
1. The importer as well as the exporter come to a consensus on a number of successive
imports that are to be carried out over a period of time ranging between 180 days and
10 years.
2. The forfaiting bank consents to finance these imports upon producing and submitting
the relevant promissory notes and other important documentation
3. The importer presents a promissory note for each import along with an endorsement by
his/her bank
4. These endorsed notes are then sent to the exporter
5. The exporter proceeds to discount the promissory notes with the forfaiter bank for an
immediate cash payment. As per norm, the discount in this situation is adjoined to the
invoice price of the products in order to shift the ultimate burden to the importer.
6. The forfaiter has one of two choices. He can either hold the notes till they fully mature
or he can discount them in the international money market. On their maturity date, the
importer is required to honour the notes presented to him. If he is unable to meet his
liability the forfaiting bank is responsible for the discharge of the importer’s liability as
against those with whom the notes were discounted.
Forfaiting is a manner of financing which is complementary to conventional export credit. Each
transaction has a volume exceeding more than USD 5 million. In order to deal with these large
amounts, multiple agencies, i.e. a syndicate, is often deployed. Forfaiting provides the
exporter with more flexibility in structuring financing deals. As it is a method that is without
recourse, all risks pertaining to credit sales can be avoided. The forfaiter bears credit risk as
well as the country risk that is associated with the transaction, liberating the exporter. If the
transaction is backed by a letter of credit or a guarantee from a bank, the risk taken by the
forfaiter is significantly mitigated.
27.18 MBF Study Module

Forfaiting has been sanctioned by the Reserve Bank of India. As per Circular No. 42 AD (MA)
Series dated 27 October 1997 authorized dealers have permission to function as
intermediaries between Indian exporters and foreign forfaiting agents.

International Working Capital Management

The management of working capital, be that at a domestic level or of an international
enterprise, remains a critical and indispensible aspect of financial management in its totality. It
has a massive impact and influence on the profitability, the liquidity and the overall
performance of a business venture.
Working capital can be understood as a circular or cyclic monetary investment that occurs
from the input stage to the final output. Its management is delicate at best due to the
fluctuations in the amount of working capital that is at the disposal of an enterprise at any
given point in time and secondly due to the obligation of maintaining an equilibrium between
the current and non-current assets for the purpose of profit maximization.
In an international sense, working capital management pertains to the management of cash
reserves, accounts receivable, the inventory and current liabilities. However, the management
of these components is done in the face of political adversity, foreign exchange volatility,
taxation norms that are challenging to navigate, and overall liquidity constraints. It also
involves short-term debt financing of current assets done through in-house banks external
local banking and financing institutions and various international commercial banks. The final
aim is to reduce funds blocked in working capital so that the enterprise doesn’t face liquidity
constraints or cash balance crunches. This process in turn augments the return on both assets
and equity. Furthermore, management of working capital should also lead to the improvement
in efficiency ratios and other performance evaluating determinants.
With respect to multinational corporations, the management of working capital becomes much
more complicated a process because these entities have operations across a diverse number
of countries. Hence, their financial transactions are carried out in a multitude of currencies. As
a consequence of this, managing short term assets and liabilities in financial terms becomes a
juggling game of constantly moving and rearranging currencies.
The rationale behind giving such importance to the management of working capital is that the
cycling of working capital is quintessential to the financial stability of any enterprise
irrespective of its nature and scale. More often than not, the amount of financial resources tied
in working capital is more in proportion to the total amount of assets in a business. Working
capital starvation is one of the biggest causes behind the failure of small scale ventures. This
is because the success of any venture is dependent upon its ability to produce receipts in
cash exceeding disbursements. The most important aspect then, of working capital
management and subsequently financial management, is the accurate forecasting of cash
requirements.
Some of the techniques involved in international working capital management are as follows:
 International Finance 26.19

International Cash Management

International Cash Management refers to the management of cash flows and liquidity of any
business that has operations in different countries as well as managing the process and risk
that accompanies both cash flows as well as capital optimization. It includes a plethora of
actions aimed at controlling the cash flow trends in an enterprise and efficiently managing
funds. International cash management has the same objectives as domestic cash
management, namely:
 Taking control of the cash resources in a speedy and efficient manner
 Ensuring that funds are optimally conserved and utilized
Controlling cash reserves ensures that cash requirements are accurately forecast and
addressed both adequately and in time to meet financing needs. This reduces the costs of
fund movements. Optimum utilization of funds means that requisite cash balances can be
decreased while money availability remains unaffected. In addition, the risk-adjusted return of
funds that may be pumped back as investments increases. Some of the techniques are
discussed below:
Electronic Funds Transfer
Electronic Funds Transfer (EFT) refers to the electronic exchange of money between accounts
within one financial institution or across multiple institutions. It covers different forms of
transfers such as card holder initiated transactions, direct deposit payroll payments, direct
debit payments, electronic bill payments etc.
Wire Transfers
Wire or credit transfers refer to EFTs from one entity to another. It can be done from one
banking account to another or through transferring cash at cash offices. This method provides
individual transactions rather than bulk payments. There are many types, systems and
operators that provide a variety of facilities with different target users and different benefits.
Payments Netting
Payments Netting is an arrangement or agreement between two counterparts that all
payments are to be netted in a single currency owed between them on a specified value date.
For every value date and traded currency, the agreeing parties will aggregate all payments
owed between them and net them in order to achieve a single currency. For example, many
companies find they can eliminate 50% or more of their inter-company transactions through
multilateral netting, with annual savings in foreign exchange transaction costs and bank
transfer charges that average about 1.5% per dollar netted. The aim is the reduction of credit
exposure to counterparts as well as settlement risk. The benefits of netting can be explained
with the help of the following example:
A US MNC with three subsidiaries has following transactions amongst them to start with:
277.20 MBF Study
S Module

Inn this examplee, the sum totaal of payable and receivable transactionss is 12, and entails
e total
traansfer of $3550: however, once these ppayments aree netted, the number of trransactions
reeduces to 2 annd the net paym
ment amount reduces to $ 555 as follows:

Sttep 1

Sttep 2
 International Finance 26.21

Hence, netting helped in cutting down total number of transactions from 12 to 2 and movement
of funds from $ 350 to $ 55. This shall lead to substantial reduction in transaction costs and
hedging costs.
Note: The above example is credited to “International Financial Management” by Eun &
Resnick, TMH Publications.
Expediting collection from International Sales
Globalization has opened up economies and increased potential markets that remain
unexploited. Increased competition and fluctuating consumer preferences and needs along
with stagnation of demand as regards domestic markets have ensured that business interests
have expanded beyond national borders. In such a scenario, international sales management
has become an integral aspect of effective financial planning. It aids in pointed implementation
of marketing policies at ground zero. Some of the techniques of expediting collections from
International Sales are hereunder:
Letters of Credit
Letters of Credit are one of the biggest tools used to facilitate large scale transactions for
international trade. They are involved in transaction between buyers residing in one country
and suppliers operating in another country. A letter of credit can be defined as a document
that has been issued by a financial institution providing for an irrevocable payment
undertaking to a beneficiary, made against complying documents that have been stated in the
credit. This undertaking can be revocable, confirmed, unconfirmed, transferable etc. It is
issued to a seller stating that the entity issuing the letter of credit will pay the seller for the
delivered goods or services. Thereafter, the issuer asks to be reimbursed by the buyer or the
buyer’s bank. A letter of credit is akin to a guarantee of payment. Hence, the seller’s risk of
non- payment is transferred to the issuer of the letter of credit.
Lockboxes
Lockboxes refer to a consortium of services provided by a banking institution involving
collection and processing. Banks collect payments from postal boxes dedicated to such
purpose by enterprises, process these payments instantaneously and credit them to the
enterprise’s account. Corporations utilize lockbox services to reduce time float. There is only
one difference between domestic and international lockboxes, that being that in case of
international lockboxes, companies employ foreign banks for collection in foreign countries.
Value Dating
Value Dating is the process of crediting all electronic payments to a buyer’s account with
money that will become available at a future date. In finance, it is the date when the fluctuating
price value of any asset is determined. It is used when there exists a scope for discrepancies
and ambiguity because of difference in timing the asset valuation. It is usually applicable to
forward currency contracts, options and various other derivatives, receivable or payable
27.22 MBF Study Module

interest. In banking terms, value date connotes the date on which the traded finds are
delivered. For the purposes of spot transactions, it connotes the future date when trade is
settled. With regard to spot foreign exchange transactions, the value date is two days
subsequent to the date on which the transaction has been agreed to.
Cash in Advance
Cash in Advance is a payment method through which the exporter avoids credit risk or risk of
non-payment as payment is made before transferring ownership of goods. Options for cash in
advance method include wire transfers as well as credit cards.
Documentary Collections
Documentary Collections is a payment method wherein the buyer and seller are familiar with
each other and minimal country risk exists. Basically, it can be understood as a time draft (a
type of foreign check guaranteed by the issuing back but not payable in full till the lapse of a
specified time period after receipt and acceptance) where documents are needed before
payment. In the process of document collection, the bank operates as a transfer agent. The
pros are that seller is protected as title isn’t transferred till payment. The cons are that
payment has to be initiated by the buyer which means that exchange rates may have altered
by the time payment has been made.
GIRO Payments
Giro (originating from the Latin term “gyre” meaning “to turn” or “transfer”) is a mechanism for
payment wherein funds are directly transferred amongst giro account holders. Companies
utilize giro payments for the purposes of managing their receivables, small scale cross-border
transactions and payroll services. Advantages are a decrease in collection float and cost. The
biggest disadvantage is for the seller because the buyer has to begin the giro payment
process.
Sight or Time Drafts
Sight and Time Drafts are used mostly in export transactions. They are both drawn by the
seller upon the buyer. They are forwarded by the seller via the bank to the buyer’s bank to be
collected. Sight drafts call for payment on presentation while time drafts do so within a specific
time period after date established by either “date’, ‘sight’ or ‘arrival’. These instruments are
significantly less secure than a letter of credit because they are unsupported by bank credit.
Factoring
Factoring refers to a financial transaction by which an enterprise sells its accounts receivables
at discount to third parties known as factors. In the case of ‘advance’ factoring, the third party
extends financing to the party selling the accounts, via a cash advance which amounts to 70-
85% of the purchasing price. The balance of the purchase consideration is paid, net of the
discount fee (factor’s commission) and other charges on collection.
 International Finance 26.23

Leading and Lagging

Leading and Lagging refer to adjustments in the times of payments in foreign currencies.
Leading is the payment before due date while lagging is delaying payment past the due date.
These techniques are aimed at taking advantage of expected devaluation and/or revaluation
of relevant currencies. Lead and lag payments are of special importance in the event that
forward contracts remain inconclusive. For example, Subsidiary b in B country owes money to
subsidiary a in country A with payment due in three months’ time, and with the debt
denominated in US dollar. On the other side, country B’s currency is expected to devalue
within three months against US dollar, vis-à-vis country A’s currency. Under these
circumstances, if company b leads -pays early - it will have to part with less of country B’s
currency to buy US dollars to make payment to company A. Therefore, lead is attractive for
the company. When we take reverse the example-revaluation expectation- it could be
attractive for lagging.
Conclusion:
In conclusion, Working capital is the support system of any business enterprise. It has a
variety of activities as components including cash management, international sales and
foreign exchange transactions. Management of working capital is a conclusive benchmark for
any successful business endeavour. Most organizations end up squandering their working
capital resources due to their cycle strategy such as that of early player and late collector.
Other organizations, especially, those that are project based or those that deal with the
manufacturing of capital goods have prolonged production cycles and end up facing cash
crunches on a regular basis because they are unable to synchronize their debt collection and
receivables with the timing of their fund requirements. Thus, efficiently managing both
receivables and payments is imperative. The motto for management of working capital should
be that minimal effort in optimization can yield untold potential. One of the most basic and yet
overlooked cash sources is Inventory. It accounts for approximately half the savings from
optimization endeavours. By streamlining of process within the firm, inventory held can be
reduced through the extent of the value chain. Decisions in this regard will change on the
grounds of different industrial standards and competitive market positions, as well as the need
to tailor them in harmony with the prevalent rules and regulations in the country of operation.
The emerging trend in international working capital management is refocusing of energies into
lowering costs and increasing efficiency. Actions and decisions should be taken with a view
not to impair flexibility nor performance.

Brief on International Taxation Structure

The international tax system is a concoction of the taxation structures of many different
nations. It mainly comprises of tax related transactions involving two or more countries. For
this purpose, it is necessary to be familiar with the fundamental precepts of taxation in all
nation states.
27.24 MBF Study Module

Taxation is based on two core principles that are abided by all systems. The first is tax
neutrality. This principle iterates that taxes cannot operate in a manner that hinders or
intervenes with the natural flow of capital in an economy. A scheme is said to be tax neutral if
it meets the following three criteria:
(i) Capital Import Neutrality: Implying that the tax burden on the subsidiary of a MNC
should be the same irrespective of the country of its incorporation.
(ii) Capital Export Neutrality: Implying that the tax structure of a country should not
incentivise the movement of capital of its citizens abroad.
(iii) National Neutrality: Implying that the tax authorities of a nationshould tax its income in
the same manner irrespective of the origin of the income.
The second principle is of tax equality. This principle implies that taxation structure should not
distinguish between the income of the subsidiary of a MNC based on the country of origin in
which the income has been earned. The income of subsidiary of a MNC should be subjected
to the same tax rate and due date for all countries.
The second important consideration in International taxation is tax environment confronting a
MNC or an investor. It depends on the tax jurisdiction of the country in which the MNC
operates or the investor has financial assets. This tax jurisdiction can be taxation on
worldwide basis or on territorial basis. Unless some solution is put into place, double taxation
of the same income cannot be avoided if nations follow both approaches simultaneously.
The worldwide approach says that the residents or corporations incorporated in a country shall
pay tax on their global income irrespective of the source where this income has been earned
or accrued. This means that a MNC with a number of subsidiaries across globe will be taxed
on the income of all its subsidiaries in its home country.
The second approach called Legal Jurisdiction Approach says that all income earned within a
country by any domestic or foreign tax payer shall be taxed, regardless of the nationality of the
tax payer. Under this approach, the national tax authorities’ tax jurisdiction is limited to the
transactions or income earned within the borders of that country.
Based on the above approach, if a MNC is based in country A and operates in country B and if
country A follows worldwide approach and country B follows legal jurisdiction approach, then
MNC will have to pay double taxes on its subsidiary income.
To avoid this double taxation, usually, countries have entered into double taxation avoidance
agreement or treaties so that there is fair play.
 International Finance 26.25

Practice Questions
MCQ
1. Which of the following would not be counted as part of incremental cash flows?
A. Opportunity Cost
B. Sunk Cost
C. External Costs such as brand cannibalization
D. External benefits such as acquisition of new technology
2. The maximum period allowed for realization of export proceeds is,
A. 180 days
B. 270 days
C. 360 days
D. Maximum period of 180 days with certain exceptions
3. Advances under Duty Drawback are made under,
A. Pre Shipment credit
B. Post Shipment credit
C. Liberalized credit
D. Packing credit
4. Pre-shipment finance is also known as,
A. Suppliers credit
B. Buyers credit
C. Export credit
D. Deferred credit
5. A MNC can centralize cash management and reduce exchange rate risk using,
A. Reinvoicing centre
B. Bill of lading
C. Time draft
D. Counter trade
6. Forfaiting most closely resembles,
A. Export factoring
27.26 MBF Study Module

B. Netting
C. Counter trade
D. Re-invoicing
7. Which of the following statements is correct?
A. If the NPV of a project is greater than 0, its PI will equal 0.
B. If the IRR of a project is 0%, its NPV, using a discount rate greater than 0, will be
0.
C. If the PI of a project is less than 1, its NPV should be less than 0
D. If the IRR of a project is greater than the discount rate, k, its PI will be less than 1
and its NPV will be greater than 0.
8. Which of the following is a legitimate reason for international investment?
A. Dividends from a foreign subsidiary are tax exempt in the United States.
B. Most governments do not tax foreign corporations
C. There are possible benefits from international diversification.
D. International investments have less political risk than domestic investments.
9. Which of the following is not the reason of international investment?
A. To provide an expected risk-adjusted return in excess of that required.
B. To gain access to important raw materials
C. To produce products and/or services more efficiently than possible domestically
D. International investments have less political risk than domestic investments
10. A shipping document indicating the details of the shipment and delivery of goods
and their ownership is are-shipment finance is also known as
A. Bill of lading
B. Sight draft
C. Time draft
D. Letter of credit
Answers
1. B 4. C 7. C 10. A
2. D 5. A 8. C
3. B 6. A 9. D
 International Finance 26.27

Short Questions
1. Discuss the twin principles of taxation. Be sure to define the key words.
Ans. The twin principles of international taxation are tax neutrality and tax equality. Tax
neutrality iterates that taxes cannot operate in a manner that hinders or intervenes with the
natural flow of capital in an economy. A scheme is said to be tax neutral if it meets the
following three criteria:
(i) Capital import Neutrality
(ii) Capital Export Neutrality
(iii) National Neutrality
Tax equality on the other hand implies that taxation structure should not distinguish between
the income of the subsidiary of a MNC based on the country of origin in which the income has
been earned. The income of subsidiary of a MNC should be subjected to the same tax rate
and due date for all countries.
2. What do you understand from Factoring? How does it help in working capital
management?
Ans. Factoring refers to a financial transaction by which an enterprise sells its accounts
receivables at discount to third parties known as factors. In the case of ‘advance’ factoring, the
third party extends financing to the party selling the accounts, via a cash advance which
amounts to 70-85% of the purchasing price. The balance of the purchase consideration is
paid, net of the discount fee (factor’s commission) and other charges on collection. This is a
good tool to collect funds from debtors after sale is completed and is therefore an important
source of working capital funds.
3. Explain FDI and its difference from FII investment?
Ans. Both FDI and FII relate to investment made by foreigners in a country. FDI refers to the
Foreign Direct Investment and is usually made in Greenfield or Brownfield projects. Usually
this investment is made by way of equity holding in 100% owned subsidiary by joint venture.
FII on the other hand means portfolio investment by Foreign Investment Institutions in the
stock market of the country. It is usually considered as hot money and, therefore, FDI is
preferred over FII investments.
4. Explain netting and its significance for MNCs in managing their cash flows?
Ans. Netting is an arrangement or agreement between two counterparts that all payments are
to be netted in a single currency owed between them on a specified value date. For every
value date and traded currency, the agreeing parties will aggregate all payments owed
between them and net them in order to achieve a single currency. The biggest benefit of
netting for a MNC is the possible elimination of 50% or more of their inter-company
transactions through multilateral netting, with annual savings in foreign exchange transaction
costs and bank transfer charges that average about 1.5% per dollar netted.
27.28 MBF Study Module

5. Is FDI permitted across all industry spectrums? Can foreign investors hold 100%
equity in any industry of their choice or are there some restrictions on their equity
holding?
Ans. In India, FDI is not permitted across all industry spectrums. Following is the list of
industries on the negative list for FDI:
(a) Lottery business including Government /private lottery, online lotteries, etc.
(b) Gambling and betting including casinos, etc.
(c) Chit funds;
(d) Nidhi company;
(e) Trading in transferable development rights;
(f) Real estate business or construction of farm houses;
(g) Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco
substitutes; and
(h) Activities / sectors not open to private sector investment- atomic energy and railway
transport (other than mass rapid transport systems).
Additionally, other than specified agriculture related activities, FDI is not permitted in
Agriculture sector/activity
Further, equity holding by foreigners ranges from 26% to 100% depending upon the nature of
industry. Therefore, foreigners are not permitted to hold 100% equity across all industries.
6. Why is capital budgeting analysis so important to the firm?
Ans. The fundamental goal of the financial manager is to maximize shareholder wealth. All
capital investments with positive NPV or IRR higher than the Wt. average cost of capital
contribute to shareholder wealth. Further, capital investment entails large capital expenditure
and execution of these projects on time and within project costs demonstrates the ability of the
firm to run its operations efficiently and effectively. Ultimately these expenditures determine
the long term competitiveness of the organisation.
Practical Questions / Case Study
1. The Alpha Company plans to establish a subsidiary in Hungary to manufacture and sell
fashion wristwatches. Alpha has total assets of $70 million, of which $45 million is equity
financed. The remainder is financed with debt. Alpha considered its current capital structure
optimal. The construction cost of the Hungarian facility in forints is estimated at HUF2,
400,000,000, of which HUF1, 800,000,000 is to be financed at a below-market borrowing rate
arranged by the Hungarian government. Alpha wonders what amount of debt it should use in
calculating the tax shields on interest payments in its capital budgeting analysis. Can you
offer assistance?
 International Finance 26.29

Ans. The Alpha Company has an optimal debt ratio of .357 (= $25 million debt/$70 million
assets) or 35.7%. The project debt ratio is .75 (= HUF1, 800/HUF2, 400) or 75%. Alpha will
overstate the tax shield on interest payments if it uses the 75% figure because the proposed
project will only increase borrowing capacity by HUF856,800,000 (=HUF2,400,000,000 x
.357).
2. Zeda, Inc., a U.S. MNC, is considering making a fixed direct investment in Denmark.
The Danish government has offered Zeda a concessionary loan of DKK15, 000,000 at a rate
of 4 percent per annum. The normal borrowing rate is 6 percent in dollars and 5.5 percent in
Danish kroner. The loan schedule calls for the principal to be repaid in three equal annual
instalments. What is the present value of the benefit of the concessionary loan? The current
spot rate is DKK5.60/$1.00 and the expected inflation rate is 3% in the U.S. and 2.5% in
Denmark.
Ans.
Year St Principal (c) StLPt StLPt/(1 + id)t
(t) (a) Payment DKK (a) x (b + c)
(b)
DKK
1 5.57 5,000,000 600,000 1,005,386 948,477
2 5.55 5,000,000 400,000 972,973 865,943
3 5.52 5,000,000 200,000 942,029 790,946
15,000,000 2,605,366

The dollar value of the concessionary loan is $2,678,574 = DKK15, 000,000 ÷ 5.60. The
dollar present value of the concessionary loan payments is $2,605,366. Therefore, the
present value of the benefit of the concessionary loan is $73,208 = $2,678,574 – 2,605,366.
3. The Eastern Trading Company of Singapore purchases spices in bulk from around the
world, packages them into consumer-size quantities, and sells them through sales affiliates in
Hong Kong, the United Kingdom, and the United States. For a recent month, the following
payments matrix of inter-affiliate cash flows, stated in Singapore dollars, was forecasted.
Show how Eastern Trading can use multilateral netting to minimize the foreign exchange
transactions necessary to settle inter-affiliate payments. If foreign exchange transactions cost
the company .5 percent, what savings result from netting?
27.30 MBF Study Module

Eastern Trading Company Payments Matrix (S$000)

Disbursements
Receipts Singapore Hong Kong U.K. U.S. Total
Receipts
Singapore -- 40 75 55 170
Hong Kong 8 -- -- 22 30
U.K. 15 -- -- 17 32
U.S. 11 25 9 -- 45
Total disbursements 34 65 84 94 277

Ans.
Step 1: Multilateral Netting
 International Finance 26.31

Step 2:

Step 3:
27.32 MBF Study Module

After completion of netting process, there is a need to remit $ 136,000 as against the initial
amount of $ 277,000 leading to saving of $ 141,000.
Practice Questions
1. Describe the key factors contributing to effective cash management within a firm. Why
is the cash management process more difficult in a MNC?
2. How would you explain the fact that China has emerged as the second most important
recipient of FDI after the United States in recent years
3. Discuss the twin objectives of taxation. Be sure to define the key words.
4. What do you understand from Factoring? How does it help in working capital
management?
5. Explain FDI and its difference from FII investment?
6. How does packing credit differ from Post shipment credit?
7. Explain netting and its significance for MNCs in managing their cash flows?
8. Is FDI permitted across all industry spectrums? Can foreign investors hold 100% equity
in any industry of their choice or are there some restrictions on their equity holding?

Bibliography
Amarchand & Mangaldas & Suresh A. (2014). Guide To Doing Business: India. New Delhi: Lex
Mundi.
Apte, P. International Financial Management. TMH Publication.
Eun, C. &. (2014). International Financial Management. TMH publication.
Misra, A. International Capital Budgeting. Kharagpur: Vinod Gupta School of Management, IIT.
Moffatt, S. &. Multinational Business Finance. Pearson Publication.
Ray, S. (2012). Managing International Working Capital Flow: An Evaluation. Journal of
Science , 13-20.