Introduction

In a growing globalized world where cash flows and flows of funds are
getting more complex one would expect businesses to be completed in
seconds through electronic transactions, which most times is also the
case. Nevertheless, the oldest form of trading and its numerous
variations regain each day their importance in international trade.
Countertrade has become an important element of the world
economy, for all countries whether industrialized, emerging or
developing since World War 2. Despite the move towards freer trade
it may be surprising to find that barter and Countertrade (CT) are
actually growing faster than world trade. International CT is a global
phenomenon which involves interaction between parties in different
countries and links sales with purchases so that each party to a
transaction is both buyer and seller at some stage. It is paradoxical
that these forms of trade, predating the use of money and trade
finance continue to grow in importance. Importance of countertrade
and its share in the world market is steadily increasing and it is
becoming one of the important opportunity for doing international
trade. As trade statistics only include monetary transactions an
increasing slice of world trade is being ignored in trade analysis,
economic, trade and policy decisions. Despite the general perception
that CT is more prevalent in centrally planned economies, their
transformation to more market based economies has not reduced the
incidence of CT as predicted. Instead more countries have come to
embrace CT. However, it would seem that although the number and
value of transactions is continuing to increase the modalities and
motivations are changing. Limited attention has been given to the

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strategic possibilities for the use of CT in the process of
internationalisation.

What Is Countertrade?

Countertrade is a resourceful way to arrange for the sale of a product

from an exporter to a company in a country that does not have the
resources to pay for it in hard currency. The problem is usually with
the importer but may be with the country's limited reserves as well.
An international credit executive who arms his salespeople with an
innovative countertrade solution gives the sales force a competitive
advantage. In some cases, the company that cannot come up with a
countertrade initiative will not be able to sell in certain markets.

The most well-known form of countertrade is barter-the

simultaneous exchange of goods. Countertrade experts say it is also
the form least Used.

Definitions
“International Countertrade”, C. M. Korth defines countertrade as “a
general term covering all forms of trade whereby a seller or an
assignee is required to accept goods or services from the buyer as
either full or partial payment.

The UN defines Countertrade as "commercial transactions in which

provisions are made, in one of a series of related contracts, for
payment by deliveries of goods and/or services in addition to, or in
place of, financial settlement".

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Four Countertrade Strategies

The countertrade strategies of American companies may be divided

into four general types, defensive, passive, reactive, and proactive.
Defensive, passive, and reactive strategies correspond to the company
advantage policy, while proactive strategy is derived from the mutual
advantage policy.

 Defensive: Companies with a defensive countertrade strategy

ostensibly do not countertrade at all; however, they make many
countertrade-type arrangements with buyer countries. These
companies will avoid any contractual countertrade obligations,
but they make it clear to the country that they will reciprocate in
some way for the sale. Some companies will sell their products
at rock-bottom prices and promise to help the country with
export development.

Others participate in barter deals by having an intermediary like an

independent trader take title to the goods on each side, therefore
making the transaction appear to be conventional import and export
rather than a swap. No matter what kind of deal is made, however,
these companies will insist that they do not countertrade. They
seldom have in-house trade units.

A variation of the defensive strategy is that of companies that say they

do not countertrade, although they do it openly and regularly with
Eastern European countries and China. They seem to think that this
trade does not count, offering the excuse that "it's the only way to do

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business in socialist countries." They may also be defining
countertrade as practice restricted to developing countries.

Incidentally, most industrial country governments that practice

military offset among themselves follow a defensive countertrade
strategy. The beneficiary countries call their requirements "industrial
benefits" and swear that they are against countertrade; the partner
countries go along with this by refusing to include military offset in
the definition of countertrade.

Examples of companies following a defensive countertrade strategy

are Bell Helicopter, Textron, EBASCO, Gould, and Borden.

 Passive: Companies with passive countertrade strategies

regard countertrade as a necessary evil. They participate in
countertrade at minimal level, on an ad hoc basis. Some
companies operate this way because they have product leverage
(i.e., little or no competition), while others follow the passive
strategy because of disinterest in countertrade.

These companies will accept contractual offset and countertrade

obligations, but only on their own terms. They will rarely obligate
themselves to export development or indirect offsets such as
counterpurchases. However, they will use countertrade for sourcing,
which is a form of export development.

Passive strategy companies regard countertrade primarily as a form

of export financing. They will not initiate countertrade or offer it as a
sales incentive; rather, they will wait until the buyer country requests

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countertrade. Some of these companies have small in-house
countertrade units.

Most chemical companies and manufacturers of chemical products

have passive countertrade strategies. These include DuPont, Dow
Chemical, Cyanamid, Smith-Kline, and the chemical divisions of
Amaco and the Ethyl Corp.

Some of the defense companies with product leverage also have

passive strategies, including Lockheed-Georgia, Martin
Marietta Aerospace, Texas Instruments, Sperry Corp., and
Singer Co. Other companies using passive countertrade strategies
are Alcoa, Polaroid, S.C. Johnson & Sons, and Nabisco.

 Reactive: This is the most common strategy among American

companies. Companies with reacting strategies will cooperate
with the buyer country in offset/countertrade requirements,
they use countertrade strictly as a competitive tool, on the
theory that they cannot make the sale unless they agree to
countertrade.

Although they may consider countertrade as a permanent feature of

their international operations, they do not see it as a marketing tool
for expansion. Reactive companies often have large in-house
countertrade units, and use outside trading companies when
necessary. They rarely have in-house world trading companies.

Most defense companies have reactive strategies. Among these are

the defense divisions of Litton, Grumman International,

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Garrett, BMY, TRW, Perkin-Elmer, Emerson Electric,
General Dynamics, Northrop, Allied Signal, McDonnell,
Motorola, ITT, Raytheon, and LTV Aerospace and Defense Co.
Non-defence companies with reactive countertrade strategies
include Kodak, Xerox, Dresser Industries, Chrysler,
Burroughs, and IBM.

 Proactive: Companies with proactive strategies have made a

commitment to countertrade. They use countertrade
aggressively as a marketing tool, and are interested in making
trading an active and profitable part of their business. They
regard offset and counterpurchase as an opportunity to make
money through trading, rather than as an inconvenience.

Proactive companies participate in all kinds of countertrade,

including global sourcing, releasing of blocked funds, trade
development, and trade financing. They often have in-house world
trading companies, and will sometimes liquidate countertrade
obligations for other companies.

Examples of companies with proactive countertrade strategies

include Cyrus Eaton, Occidental Petroleum, Continental
Grain, Caterpillar, Monsanto, General Foods, Goodyear,
Rockwell, General Electric, FMC, Westinghouse, Tenneco,
3M, General Motors, Ford, Coca-Cola, United Technologies,
Pepsi-Cola, and the civilian product divisions of McDonnell and
Lockheed

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Types of counter trade

Countertrade is quite simply the exchange of goods for goods, but it is

also a barrier to free trade. The simplest form of countertrade - barter
- dates from ancient times, but more recently various other forms of
countertrade have been used in trade between rich and not so rich
countries. Due to shortages of foreign exchange and a lack of markets
for their products, many nations have engaged in countertrade. For
example, Iraq obtained warships from Italy in exchange for oil; Spain
obtained Colombian coffee in exchange for Spanish buses.

Countertrade is a barrier to free trade because the sellers are obliged

to take goods they would not otherwise buy, and in doing so, they
close off a market from free and open competition.

 Barter: Is the direct exchange of goods between two parties.

The advantage of barter is its simplicity.
One disadvantage is that unless goods are swapped
simultaneously, one party is financing the other until the
exchange is complete. A second is that the goods exchanged
may not be goods one or both parties really want, or may be
ones that are difficult to convert into cash.

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  Counter purchase: The assumption by an exporter of a
transferable obligation through a separate but linked contract to
accept as full or partial payment goods and services from the
importer or importing country. The contract usually stipulates
a period during which the counterpurchase is to be completed,
and the goods and services received in return are pre-specified,
subject to availability and to changes made by the importing
country. In essence, counterpurchase represents an inter-
temporal exchange of goods and services or the bundling of two
transactions, namely current buying and future selling.Is a
reciprocal buying agreement (not a direct exchange of goods).
The advantage is that both parties get goods they can use or sell.
The disadvantage, however, arises when one or both parties
have to engage in a further transaction to dispose of the goods
to obtain more useful goods.

 Offset trading: Is an obligation imposed on exporters by

governments which requires local industry to be given the role
of producing goods to offset the purchase price of expensive
products.

Offset trading can be done through co-production, sub-contracting,

joint ventures, licensing or turnkey arrangements. The offset
arrangement is common with expensive items such as military
equipment, aircraft and ships. The principal reason for this form of
countertrade is to offset the negative effects of such large purchases
on the balance of payments of the importing country.
Offset trading offers the advantage of offsetting the balance of

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payment effects for the country importing large outlay items.
The disadvantage is that it requires the exporter to deal with a firm in
the importing country, which may not be the exporter's preferred

 Switch trading: It involves at least three parties. A switch

trade is used when the products received are of no use to the
exporter or cannot be converted to cash. The original exporter
may then barter the goods received for other products which
may be sold for cash. This chain of transactions may be
repeated a number of times. As a result, this expands the
number of goods that may be bought and sold. Switch trading is
useful to a country with unique requirements or goods and can
open untapped markets. The advantages in switch trading are
that it enables the parities to achieve a satisfactory outcome and
expands export markets. It is, however, sometimes difficult to
arrange and may require the services of specialist brokers
course

 Buyback or compensation trading: This is probably the

most common form of countertrade. It usually consists of the
export of a technology package, the construction of an entire
project or the provision of services by a firm. The buyer in
return pays back the supplier by delivering a share of the output
of the project in the future. For example, in 1980 the German,
French, Italian and British governments subsidized companies
to construct a $US 4 billion natural gas pipeline in the former

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 Soviet Union . The former Soviet Union paid for the project
with natural gas.

The advantage of buyback trading is that it acts as a substitute for FDI

in countries which do not welcome FDI.
The disadvantage is that few situations are amenable to this form of
countertrade.

Reasons why counter trade is used:

• Money - some people cannot pay in the currency you want

"to enable trade to take place in markets which are unable to
pay for imports. This can occur as a result of a non-convertible
currency, a lack of commercial credit or a shortage of foreign
exchange"
• The Political Environment - local jobs and industry
"to protect or stimulate the output of domestic industries
(including agriculture and mineral extraction) and to help find
new export markets"
• The Political Environment - rules and regulations to protect the
host country
"as a reflection of political and economic policies which seek to
plan and balance overseas trade"
• "To gain a competitive advantage over competing suppliers."

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Documentation

Never assume that the other party will perform in a certain way when
entering a countertrade arrangement. The documentation, typically
prepared by the party arranging the transaction, should:

• connect all parties together;

• state the purpose of the trade;
• state the responsibilities of the participants; and
• summarize how the transaction will run.

The documentation should include:

• the terms of the underlying contract(s);

• the requirements of each party;
• any local regulations that affect the trade;
• timing;
• any financing requirements; and
• how the arranger will receive its fee.

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 Adverse effect and managing risk In Countertrade
Transactions

One of the unique risks of countertrade transactions is that

companies often find themselves handling products with which they
are not familiar. This is probably the greatest risk in a countertrade
transaction.

1. Liability for the Product on Resale

If you acquire title to the product (and even if you do not acquire title
under certain circumstances) and the product causes damage to third
parties, fails to meet the standards normally expected for the product,
or fails to meet the warranties and/or guarantees for the product
being sold, you can find yourself liable to third parties...including
your customers and independent third parties.

As a manufacturer of a mechanical product or a supplier of

technology, to find yourself the seller of medical equipment,
consumer goods, raw materials, et cetera, for which there is a legal
claim can be a very disturbing and expensive learning lesson.

Managing risk: The suggestion for managing the risk is do not take
title to the product; this should be obvious advice. One suggestion is
to use a trader or other intermediary who can be responsible for the
potential liability. Either they can ensure that the product does meet
the requirements of the market or the contract, or they can better deal
with the failure by substituting alternate product, or dealing with the
claim or lawsuit.

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 2. Currency Risks

There are really two main currency risks. The first is non-
convertibility, i.e. the currency will not be convertible when received
or required. As many countertrade transactions are designed to avoid
this problem, this is less of a risk than might be expected. The second
risk is that the currency will have fluctuated in value, and that you
will receive fewer dollars than you expected.

Managing risk: The risk of non-convertibility through government

action can probably be covered by political risk insurance.
Alternatively, you could get a government guarantee that you will be
allowed to convert currency as required. Of course this may not be
much of a guarantee if the government changes its mind or a new
government is in place, but it also might be insurable.

Currency fluctuations are often capable of being protected by

currency hedging contracts. These are possible on all hard currencies
and on many soft currencies through specialist traders.

3. Non-Performance

This is obviously the most common risk in any transaction. This risk
may be higher in countertrade transactions, as you are probably
dealing with less developed countries and less sophisticated sellers.

Non-performance can take many forms, including complete failure to

deliver, late delivery, partial delivery, or delivery of damaged,
defective, or out-of-specification product.

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The effect of non-performance will be different under different
contracts, and depends on the nature of the non-performance. It can
render the sale of your product impossible, and/or failure could leave
your company open to claims or lawsuits from unhappy buyers.

Managing risk:

1) Make reasonable contracts. The most effective manner is to ensure

that the transaction works. The surest arrangement is to deal with
competent and experienced partners. But, as we are all aware, this
may be extremely difficult in countertrade transactions, especially in
developing countries and in countries which are changing from a
centrally planned economy to a free market economy.

A good solution is to make contracts which you are comfortable that

the other party can meet. There is no point in forcing another party to
accept a contract which you are convinced that they cannot fulfill.

2) Use traders. Another solution is to use other parties that are

experienced in the country and/or product to handle the
import/export of the products. In other words, use an experienced
trader.

Generally a trader can better assess and manage the risks than an
industrial company attempting to sell its product to the third-world
country. The use of third party experts will probably assist you to
avoid many risks, and will make the transaction more likely to occur.

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3) Use insurance. You may be able to insure the risk under certain
circumstances. Political risk insurance has far broader coverage
application than you might expect.

It is available to cover the failure of the seller for almost any reason,
not just failure to perform because of government action. The
insurance is generally available only for sales by government-owned
enterprises, although other similar coverages may be available.

4) Get guarantees. If you cannot ensure that performance will occur,

you should protect yourself from the effects of failure, as much as
possible.

In general, some form of guarantee of performance is usually

prudent, these guarantees can include standby letters of credit,
performance bonds, bank guarantees, cash deposited in an escrow
account, product delivered to a neutral party, or government
guarantees, etc.

4. Payment Risks & Creditworthiness

Payment risk is not a common risk for the countertrade transaction,

as you are purchasing, not selling product.

However, if your barter transaction requires that a short-fall be paid

in cash, there may be a payment risk. There is a credit worthiness
issue if you are required to make a claim against the seller.

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A party failing to pay because it is bankrupt or because it doesn't want
to pay, for whatever reason, is an extremely difficult problem in an
international transaction.

Managing the risk: The traditional method is to use a letter of

credit (L/C) from a reputable bank. If the (L/C) is not from a reliable
bank, it can often be confirmed by a reliable bank. Or the L/C can be
insured or discounted.

Other methods of handling this risk are to insist on security deposits,

or to require guarantees from other parties working with the seller
who are easily sued.

5. Timing Risks

Timing can be a risk in many ways. If your supplier fails to deliver in

time, you may be liable to another party who was expecting to receive
the product.

Other timing risks impact on currency risks or payment risks. For

example, if your L/C expires before delivery, you are not guaranteed
payment. Or if your hedging expires before delivery, you may not
receive the money you expected.

Managing the risk: This risk should be generally managed in the

same manner as non-performance. The risk of delay impacting on
your hedging contracts or your L/Cs requires careful management of
your countertrade contract.

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 6. Risks Arising From Government Regulations

There are several legal risks to international trade transactions, such

as anti-dumping, embargoes, quotas, licensing, sovereign immunity
and foreign corruption

a) Dumping. This occurs when a seller sells a product into another

market at prices less than the home market, or at prices less than its
cost. Often it is more difficult to obtain the real price for the
countertrade product than it is for traditional sales.

The penalty for dumping is an "anti-dumping duty" which is

chargeable to the importer of the product. Obviously this could have a
detrimental effect on pricing and the countertrade transaction.

Managing the risk: The safest method of handling dumping

problems is to use a trader or to act as a broker and have another
party import the product.

If you must be involved, you should provide in your contract that any
anti-dumping duties are for the account of the seller and should
obtain security for this if it is a likely risk.

b) Quotas. These are agreed limits on the volume of product that

can be imported into a country. For example, there might be an
agreement between China and the USA in which only 20 million
items of a textile product can be imported into the USA in any one
year.

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If your countertrade transaction involved the import of the next 2
million items, you would not be allowed to import them.

The transaction would therefore fail or be delayed until the quota

opened again in the succeeding year. If you have already delivered
your product to the Chinese importer, you might have to wait for
some time. And this could have a negative impact on your
profitability.

One of the problems with the quota system is that the Customs
Service in the importing country will simply refuse to allow additional
product to land.

It is difficult to obtain accurate information on what quantity has

landed, and the situation can change very quickly if new product
lands between your inquiry and your product's landing.

Managing the risk. Quotas should also be left to the seller to

obtain, as the responsibility for managing quotas rests with the
exporting country. Alternatively, you could use a trader to avoid the
risk.

c) Embargoes. Certain countries, e.g. Iraq, are subject to embargo

regulations, and any attempt to deal with products from these
countries or to deal with companies/individuals from these countries
may be a criminal offense.

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Managing the risk. While you may know that you cannot deal with
Iraq or other countries subject to embargo, you may not know, say,
whether or not the company in Cyprus (which has offered you steel
from Romania) is owned by a company in an embargoed country.

It is often extremely difficult to ensure that you are not dealing with a
restricted company.

There is no easy solution to the problem, and checking the regulations

to determine whether your partner/seller is subject to embargo is
time consuming, and probably not reliable.

d) Licensing. Failure to obtain a required license can mean that

your product is not exportable from a selling country, or importable
in a buying country. And this could obviously have an extremely
negative impact on your countertrade transaction.

It is standard risk in all international trade transactions, and there

has been much litigation resulting from parties failing to obtain
licenses and determining who had the obligation to obtain the license.

Managing the risk. In order to avoid problems with licenses, the

obligation of either of the parties to obtain the necessary licenses
must be clearly agreed to in the contract.

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e) Sovereign immunity. This is not the result of government
regulation, but is a legal doctrine which prevents lawsuits against
foreign sovereigns.

In other words, you cannot sue foreign governments. Unfortunately

many foreign governments operate business or quasi-business
operations, and sometimes these organizations are provided with
sovereign immunity.

If you deal with one of these entities and attempt to sue on a failed
transaction, you will be prevented from doing so by most courts.

Managing the risk. A simple and expedient solution to the problem

is to ensure that the other party waives any defense of sovereign
immunity.

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Countertrade Examples

1. Pepsi & Vodka

The countertrade arrangement where the rights to sell Russian
vodka in the US in exchange for Pepsi (to be sold in Russia) was
a huge story years ago

John G. Swanhaus, Jr., vice president, Pepsi Cola Company

As president of PepsiCo Wines & Spirits International, a major part of
his responsibility was PepsiCo's supply to the U.S. market of
Stolichnaya Russian Vodka as part of a countertrade agreement to sell
Pepsi products in the Soviet Union. Pepsi & Vodka -how did it work,

Pepsi-Cola delivers syrup that is paid for with Stolichnaya Vodka.

Pepsi has the marketing rights of all Stolichnaya Vodka in the U.S.

Recently Pepsi has made another innovative step by taking 17

submarines, a cruiser, a frigate, and a destroyer in payment for Pepsi
products. In turn, this rag tag fleet of 20 naval vessels will be sold for
scrap steel, thereby paying for Pepsi products being moved to the
Soviet Union.

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Conclusion
Countertrade commitments do not come without risk. Risk, however,
can be minimized with proper planning, appropriate products,
internal communication and an effective protocol contract. When all
aspects of a countertrade agreement are in place, countertrade is a
great tool to create and improve international sales

Choosing a CT strategy has implications for the modalities selected in

particular the key characteristics of temporality, commitment and
company advantage. In turn the CT strategy pursued will in part
determine the contribution to internationalisation. Such contribution
can be measured along the dimensions identified in the
internationalisation literature. Empirical evidence is supportive of a
two-stage model in which the second stage, the internationalisation
process is moderated by the choice of CT strategy. The companies
described here show wide diversity in CT used and in their
internationalisation processes. It provides a challenge for further
conceptual and empirical development to refine the model. This
paper gives initial thoughts on the relationship between CT and
internationalisation and suggests an approach to gain further
understanding.

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 INDEX

SR. NO.
TOPIC

1. Introduction

2. What is counter trade?

3. Four countertrade strategies

4. Types of counter trade

5. Reasons why counter trade is used

6. Documentation

7. Adverse effect managing risk in countertrade

8. conclusion

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Project on: adverse effect of
countertrade
ROLL NO: 21 & 26
SUBJECT: international
banking finance

SUBMITTED TO: kanthi

MAM

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Four Countertrade Strategies

Defensive. "Companies with a defensive countertrade strategy ostensibly do not countertrade at

all; however, they make many countertrade-type arrangements with buyer countries. These
companies will avoid any contractual countertrade obligations, but they make it clear to the
country that they will reciprocate in some way for the sale. Some companies will sell their
products at rock-bottom prices and promise to help the country with export development."

Passive. "Companies with passive countertrade strategies regard countertrade as a necessary

evil. They participate in countertrade at minimal level, on an ad hoc basis. Some companies
operate this way because they have product leverage (i.e., little or no competition), while others
follow the passive strategy because of disinterest in countertrade."

Reactive. "This is the most common strategy among American companies. Companies with
reacting strategies will cooperate with the buyer country in offset/countertrade requirements, they
use countertrade strictly as a competitive tool, on the theory that they cannot make the sale
unless they agree to countertrade."

Proactive. "Companies with proactive strategies have made a commitment to countertrade. They
use countertrade aggressively as a marketing tool, and are interested in making trading an active
and profitable part of their business. They regard offset and counter purchase as an opportunity
to make money through trading, rather than as an inconvenience."

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