Analyzing Risk Management for Exporter of French Luxury Goods Assessment Answer
Reviewing and Analyzing the risk management for an exporter of French luxury goods who has to export goods to South Africa of Contract value is €50,000.
1. Country Risk for South Africa:
The country risk analysis is based upon various factors like the sovereign risk, currency risk, political risks, economic structure risks, banking sector risks and business environment risks. The economic freedom of the country is ranked at 102 in the world. The country has an above average favorable business environment with improving policies towards free enterprise and competition and favorable foreign trade and exchange controls (Societe Generale, 2020).
The economic growth of the country is expected to remain decent at 1.2% in the year 2020. Though the COVID Pandemic will affect the global economy and South Africa will not be spared.
The strengths of the country (Euler Hermes, 2020):
- Availability of natural resources like Gold, platinum, chrome, manganese, coal and diamonds
- The judiciary and business laws are aligned with the western countries
- A sound record of monetary and fiscal polices (economic management) with flexible exchange rate
- The country exemplary performance on exodus from foreign debts.
- The country has good and advanced service sector especially in financial field. Thus there will help available from IFIs in case of need.
Weakness of the country:
- The country has poor debt ratios which are getting worse. The public debt is on risk. It has both current and fiscal account deficits
- Unemployment, poverty, low incomes leads to increased crime rates and are the reason for social risk
- The investment in the country is dependent upon uncertain foreign investments. There is high inflexibility labor market.
2. Risk management strategies:
Risk management strategies are adopted to minimize the risk during any financial transaction with other country. The two commonly adopted risk management strategies are:
- Export Credit Insurance: Export credit insurance covers the financing that the seller gives to the buyer of goods and services, also known as supplier credit in case of exports. The insurance covers the commercial risk ( to enable the buyer to pay the cost of the goods purchased) and political risks (the changes in the government policies of the buyer country that might affect the business transaction negatively).
This risk management strategy is not a guarantee or bond which is one sided but is based upon the mutual relationship of the insurer and insured. The insurance can be taken out for different phases like the shipment only or the production period as well. The insurance is generally planned on percentage of coverage basis and there is some portion of transaction which remains uninsured. The uninsured percentage is generally 10%. Private insurance cover is available for less than 2 years period and covers the commercial risk mainly. The government insurance is available for longer periods. The Export credit insurance is more prevalent in OECD countries as the commercial and political risks are lower. The insurance covers are normally facilitated by the Export Credit Agencies (ECAs) which act as intermediaries between the exporters and the governments of the countries. The premiums of the insurance cover are about 1% and varies with the risk involved in the country where the buyers are located, industry type, financial position of the customers and their payment histories.
- Bank Guarantees: These are guarantee or the letter of credit with the flat handling charge and an interest charged on the basis of the guarantee amount. The cost of the guarantees is not fixed/standard and depends upon the credit worthiness of the buyer, his country, the currency of transaction and other related facts about the transaction. The interest changes can range from 0.5 to 2 % per year. The guarantee can be of various types like the contract guarantee (based upon full recourse), Tender guarantee or bid bond (guarantees that the seller will sign the contract if the bid is successful), Advance payment guarantee (covers the advance payment given by the buyer to the seller, in case the seller is not able to deliver the goods),performance guarantee (seeked along with advance payment guarantee to ensure that the buyer is compensated in case the seller fails to deliver the goods). All the guarantees are based upon the basic contract like the date and validity, the currency and the amount and the coverage of the guarantee. Since the laws in the two countries may be different therefore the guarantees have a reference to the applicable laws and jurisdiction. Generally the applicable law is the law of the country of the seller. The guarantee becomes payable when the bank that has issued the guarantee verifies that the principal (buyer) has defaulted on his obligations.
3. Preferred strategy
The seller is an exporter of French luxury goods to South Africa of contact value €50,000. The risk involved is the payment risk by the buyer being the commercial risk and also the political risk because all the countries are revising their foreign trade policies in view of current pandemic uncertainty.
The cost of Export credit insurance will be about 1% of €50,000 = €500.
The uninsured amount or the risk will be nearly 10% = €5000
In case of bank Guarantee the normal rate is 0.5-2%, considering it will 1% for South Africa the cost will be €500
The bank guarantee is for the full amount and in case the buyer is not able to pay the amount the bank will pay the full amount to the seller.
The risk management though Bank Guarantee is better in this situation for the following reason:
- The risk exposure is less
- It is easier for the seller to get the bank guarantee based upon his credit from the local banks in his country through his personal relations.
- Since the guarantee are governed by the seller county jurisdiction it will be easier for the seller to enforce the guarantee and not involve much travel and hassle.
- The seller can attain guarantee on the advance payment as well or can customize it according to his needs
- Since the export is of the luxury goods, there is uncertainty around the industry because of the global pandemic and the demand may come down drastically as the economy is facing down turn all over the world. Thus the possibility of default in payment by the buyer are higher and hence its more advisable to go for bank guarantee.