(Reprinted from BarterNews issue #37, 1996.)
The Changing Role Of Countertrade And Other Contract-Based Practices In International Trade *
of paper presented at the International Trade and Finance Association
Pompiliu Verariu, U.S. Department of Commerce,
(* The views expressed in this text are those of the author and do not necessarily represent those of the International Trade Administration, the U.S. Department of Commerce, or the U.S. Government.)
Following the emergence in the mid-1970s of countertrade transactions in trade with the then command-economy countries of Eastern Europe and the Soviet Union, the practice proliferated rapidly and, by the end of the 1980s, had spread geographically to over 100 nations.
Countertrade deals would typically entail two contractually-linked import/export transactions, each settled through letter of credit payment.
In the belief that countertrade arrangements could alleviate net outflows of scarce hard currency resources and help finance critical imports, many developing country governments enacted legislation which enabled private sector enterprises--or directed state-owned enterprises--to participate in countertrade deals.
For many hard currency-strapped Third World countries struggling to cope with the rising prices of their energy imports, linking imports from industrialized countries to domestic exports seemed like a reasonable way to finance the imports and expand exports.
Bilateral trade under government-to-government clearing agreements was, after all, the way much of intra-developing country trade was conducted in the 1970-80s. Clearing trade--whereby two or more countries agree to exchange a number of specific products over one or more years and the value of the traded goods is denominated in accounting units expressed in major currencies such as the U.S. dollar or the Swiss franc--has now been practically phased out in international commerce. In the 1970s, however, it accounted for an estimated 10% of world trade.
Because the format and use of countertrade transactions have evolved over the years, this paper will use the term "countertrade" in a generic sense.
The term will denote practices whereby foreign suppliers commit, as a condition of sale, to reciprocate and undertake certain contractually specified commercial initiatives that "compensate" the buyers through transfers of various agreed upon economic benefits (e.g., payments in kind that minimize or avoid net hard currency outlays by buyers, marketing assistance in third markets, investments and job creation in the buyer's country, or a combination of these.)
I. The 1970s and 1980s
Judging by analyses of reported transactions, the number of countertrade transactions apparently peaked in the mid-1980s or in the later part of that decade in the number of transactions executed and their dollar value.
The actual volume of such deals, as a percent of total world trade, can only be estimated because of the spotty information available. Contributing to widely varying figures are assessments that either lump together or exclude different categories of compensatory arrangements (e.g. government-to-government clearing agreements, military offsets).
Estimates in the mid-1980s placed the annual volume of international deals conducted under the generic label of countertrade between 5% and 25% of total world trade--that is, somewhere between about $80 and $240 billion.
Also significant was the rapid geographical spread of the practice during the 1970-80s. A study based on a survey of 110 U.S. firms by the National Foreign Trade Council Foundation reported that the number of countries making countertrade demands increased from 15 in 1972, to 27 in 1979, to 88 in 1983.
An alternate indicator of rising countertrade pressures during the period was the involvement of the U.S. business community with the practice
. A U.S. International Trade Commission study that surveyed 523 U.S. corporations accounting for $127 billion in export sales in 1984 (about 60% of total U.S. export sales that year), reported that 5.6% of military and non-military export sales that year involved countertrade obligations.
The study reported that between 1980 and 1984, defense countertrade obligations of U.S. firms increased from $414 million to $2,182 million, while non-military countertrade obligations increased from $467 million to $580 million.
Developing Countries: Countertrade with developing countries constituted the bulk of such deals between suppliers from industrialized countries and developing country importers in the 1970-80s.
The transactions involved traditional Third World exports--mostly agricultural commodities and crude oil.
By the mid-1980s, supply and demand constraints in volatile commodity markets contributed to a leveling in the volume of countertrade commodity deals, while countertrade arrangements involving value-added processing and buy-backs of light industry goods and low-technology components multiplied, particularly in China and other South-East Asian countries.
The format of countertrade transactions and the nature of the assets exchanged also evolved during the late 1980s, reflecting increased sophistication in structuring such deals and the inclusion of a broader asset basis in countertrade arrangements.
In addition to physical goods, such as equipment and commodities, items transferred under reciprocally-linked deals included services such as transportation services and construction engineering, intellectual property rights such as licensing, rights to the use of assets such as leasing, and even outstanding commercial and national debt which was settled through repayments in products (e.g., commercial debt-for-product swaps in Peru and settlement of Libyan government debt through oil deliveries.)
A major application of countertrade in the 1970s was in buy-back transactions--a contractual agreement whereby foreign contractors accept as full or partial repayment goods derived from the plant or machinery they supplied.
Buy-back arrangements financed construction of much of the new production capacity in the Soviet Union.
Countertrade techniques were also used occasionally in freeing blocked soft currency funds.
These funds--held in countries with currency controls, such as India and the former Yugoslavia, and representing local earnings by foreign firms or nationals--were sold at a discount, with official permission, to other Western parties who used them to cover local costs for such activities as producing films.
Industrialized Countries: Counter-trade practices were not solely restricted to trade with developing countries, as evidenced by the creation in the 1980s of public units in industrialized countries entrusted with administering compliance with both defense and non-military offsets.
Offsets--an umbrella term for a broad range of industrial and commercial compensation practices required of foreign suppliers under primarily government agency of state-owned enterprise acquisitions--were made a common requirement for the procurement of either military (e.g., fighter aircraft) or high-cost civilian hardware (e.g., commercial aircraft).
Both defense and non-military offsets may entail overseas co-production of the procured item, as well as other economically beneficial transfers to the importing country that are not related to the original export.
Industrialized countries that established offset programs tied to both civilian and military procurements in the 1980s include Australia, Austria, Belgium, Canada, Greece, Turkey, Portugal, Norway, Sweden, Finland, and Spain.
To assist their exporters some industrialized country governments also promoted countertrade under government agreements.
For example, the French Ministry of Agriculture signed in 1989 an agreement with the USSR Council of Ministers which provided for exchanges of Soviet commodities for French agricultural and food processing equipment and technologies.
Other Western governments, such as those of the United States, Canada, Belgium, Holland, the United Kingdom, and Italy, established special countertrade service units within public agencies to provide countertrade-related advisory assistance to their exporters.
The French Government has supported instead the formation of a separate countertrade assistance entity in the private sector. The Swedish Government was until 1990 a major stockholder, through interests by the Swedish Investment Bank, in a private sector company involved in countertrade, Sukab.
II. The 1990s
In the 1990s, countertrade pressures abated in many parts of the world, notably Latin America as a result of debt reduction induced by the Brady Plan initiative, lower international interest rates, policies that liberalized trade regimes, and the emergence of economic blocs such as NAFTA (U.S., Canada, Mexico), and MERCOSUR (Brazil, Argentina, Uruguay, Paraguay) which integrate regional trade based on free market principles.
International countertrade practices are now increasingly associated with bidding on major defense and non-military government procurement contracts and with project financing--a contract-based, off-balance-sheet finance technique whereby revenues generated from the output of the financed project are directly allocated to service outstanding debt and principal.
A variation of the countertrade buy-back contract which links foreign contractors' repayments to the output products of the production capacity they supplied, project financing relies instead mainly on contractual recourse to the project's revenue streams.
Strongest pressures for compensatory arrangements are currently tied to offsets in government procurements. The end of the geopolitical struggle against communism has shifted the focus of global rivalry to the commercial arena--mainly commercial competition among industrialized democracies.
Shrinking national defense spending in Western countries (over 35% in the U.S. since 1990) and declining international orders for weapons are forcing U.S. defense contractors to undergo mergers and to outbid each other for declining sales in the international marketplace--mostly by increasing the level of the offset obligations they assume.
On their part, developing country governments are increasingly shifting their focus to civil procurements--commercial aircraft, industrial plants, and especially infrastructure projects such as roads, telecommunications, and power projects.
(According to the World Bank, developing countries are now spending around $200 billion a year on new infrastructure investment, one-fifth of their total investment.)
High procurement costs and tighter budgets have prompted many emerging country governments in the 1990s to issue new civilian offset regulations (e.g., United Arab Emirates, Kuwait).
Civil offset requirements, therefore, are increasingly acquiring a financing rationale in these markets.
In a global environment of budgetary constraints, the ability of suppliers to meet offset requirements and/or to provide their clients with financial packages that can best those of competing bidders is a major competitive edge.
Countertrade pressures are also on the rise in the former Soviet bloc countries.
Since the advent of "perestroika," the emerging democracies of Eastern Europe and the successor states to the former Soviet Union have embarked on a path of gradual economic reform, shifting away from central planning toward individual forms of market-driven economies.
The nations' requirements for huge amounts of foreign funds are, however, constrained by the countries' limited number of investment and/or business opportunities, by low creditworthiness, and by the need to compete for private capital with more profitable and risk-free markets.
Today, Eastern Europe and the newly independent republics of the former Soviet Union still grapple with economic dislocations associated with reforming and reconstructing their obsolescent economies. The self-financing aspects of countertrade arrangements appeal to these countries' governments as one alternative for financing trade and investment linked to privatization and modernization of existing production capacity.
Countertrade practices have traditionally played a significant role in the commerce of the former command economies of Eastern Europe and the Soviet Union.
In the late 1980s, well over half of the former Soviet Union's trade was conducted on the basis of countertrade, the bulk of it under bilateral clearing agreements with Central Europe and a number of developing countries.
The concept of payment in goods lent itself well to the region's centrally-planned system which was not based on profit-oriented flows of money as a me dium for settling transactions, but on an accounting system for uses of domestic resources.
Faced with declining intra-regional trade levels and dislocations in feed-stock sources induced by the demise of the regional clearing system, the Newly Independent States (NIS) of the former Soviet Union are restoring former commercial links between themselves and with East European countries by conducting a significant portion of trade on the basis of cashless barter.
According to the Russian State Statistics Committee, barter transactions accounted for 11.5% of all Russian exports in 1993 ($4.9 billion), compared with 8.3% in 1992.
This figure is a lower limit since it does not account for buy-back transactions, unreported non-government barter deals, and countertrade arrangements financed through offshore escrows. The Russian Government has also bartered products (including military hardware) to settle outstanding debt owed to Turkey, Hungary, Finland, and South Korea.
Other former Soviet republics, less versed in bilateral barter agreements than Moscow, have been more reluctant to enter into such arrangements. All exert strict controls on barter and countertrade deals involving strategic raw materials.
Barter arrangements are, however, impractical in trade with Western suppliers because such deals seldom satisfy the trading partners' coincidence of needs for each other's products.
Because Western suppliers can no longer rely on commercial credit extensions to finance the export leg of countertrade transactions, they must now generate in advance, on behalf of the NIS importer, the foreign exchange required to finance the Western export.
The advance generation of foreign exchange is accomplished through the sale of NIS goods whose proceeds are then escrowed offshore in order to secure timely payments to the Western suppliers.
Hence, the emergence and proliferation of offshore escrow accounts endowed by commodity sale proceeds which have now substituted for previous countertrade practices involving linked, financially settled, and offsetting import-export contracts.
Escrow-financed trade that relies on commodity exports has become a significant and common tool in trade of the Russian Federation. In 1992, the Russian Market Research Institute of the Ministry of Foreign Economic Relations estimated that about 10% of annual hard currency export revenues--or as much as $4 billion annually--is escrowed abroad.
About 80% of these funds is then used to finance imports into Russia. In 1994, the Russian Central Bank raised these estimates. According to the bank, about $22-23 billion was escrowed offshore in 1992 and 1993, out of a total value of $70 billion exported in two years.
Escrow-financed trade appears to enjoy the support of both central and regional governments in the Russian Federation, as regions and major energy producers are entitled to retain hard currency earnings derived from exporting a portion of their production for their own development.
In 1992, approximately 10% of the production of Russian regions was exported through such regional quotas. For production enterprises, countertrade fulfills a role that ranges from financing critical imports to stashing foreign exchange export-revenues offshore.
Worldwide economic liberalization measures are now providing new business opportunities for industrial country exporters and investors, while global trends for increased reliance on private capital flows and decreased dependence on sovereign guarantees are pushing contract-based financing techniques to the fore.
These trends portend that contract-based financing tools such as countertrade--not withstanding any heightened costs and risks they pose to the trading parties--will likely continue to find use in trade with debt-ridden countries for transactions lacking cover from multilateral development banks and Western export credit agencies.
By relying on multiyear marketing commitments for counter-delivered goods, countertrade arrangements ensure continuity in repayment flows.
In the absence of sovereign guarantees, countertrade contracts may also provide a legal mechanism that could enhance the opportunity for liquidating debt in case of default on the part of one of the parties to the contract.
Thus, financing based on countertrade and other similar contract-based self-liquidating financing arrangements is likely to continue as a way of supplementing traditional export finance business.
Key to the market acceptance and successful outcome of such transactions
will, however, be the way costs and risks will be shared among trading
parties, inclusive of government agencies.
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