It isn't often that a simple switch of letters from U-S-A to U-A-E can lead to a loss of over Rs 6 crore. But commodity traders in India are only too aware of how the global credit crunch is changing the rules of the game. Suppliers and buyers are using any opportunity to renegotiate their contractual obligations, and in some cases, wriggle out of them entirely.
Take the instance of Surya Alloys, a Kolkata-based company that was due to receive a 3,000-tonne shipment of ferrous scrap from Dubai-based Goldline Worldwide. The suppliers who received the invoice or Letter of Credit (LC) on October 8, quickly noticed discrepancies in the letter: the place of origin was written down as UAE instead of USA (where the shipment was coming from), and statements like "free on board"--meant to ensure there were no charges by the shipping line for carrying the material on board--were instead replaced by "clean on board" (this indicates the shipping line should undertake an inspection of the goods on board). When the suppliers asked Surya Alloy to make amendments, they were told the LC would only be reworked if the price was dropped sharply, from the current $430 per tonne to $180 per tonne.
"The companies which are honouring their contracts, those you can count on your fingertips. Most trading companies in India are owner-driven and not as professionalised, so most are backing out," explains an executive from one of India's leading manufacturing and trading companies.
Goldline's shipment has already left US shores. A source involved in the deal confirms the company is now hoping to sell off the shipment at a reasonably lower price to other buyers or face the prospect of a $1.29 million loss.
JP Morgan's executive director, Trade Finance & Logistic – South East and South Asia region, Sonam Kapadia, agrees that buyers and suppliers are taking a closer look at their terms, and that banks too are very cautious in handling transactions. "Both the buyer and supplier are under a great deal of pressure due to the issue of price volatility and constraint on credit. Banks are responding to the heightened risk environment by re-examining their portfolio. This impacts the availability of credit for buyers, especially in commodity transactions."
In most commodity transactions, instead of paying the seller in cash or cheque, the buyer gives a line of credit. This is a document issued by a financial institution, from the buyer's side, assuring that the payment will be done within a stipulated period of time. This period usually lasts up to 180 days and the interest rate charged ranges about 100-250 basis points (1%-2.5%) above Libor (the London Interbank offered rate). This document goes from the buyer's bank to the seller's bank. But during a downturn or a recession, similar to the present one, banks refuse to give lines of credit, fearing defaults. This severely limits the buyer's capability to trade.
So a heightened risk environment results in banks refusing to extend lines of credit to each other, and buyers find it hard to finance their deals.
Only this week, one of the country's leading specialty steel manufacturers had struck a deal for a shipment of 2,000 tonnes of steel scrap from their supplier, a US-based trading company. The transaction would have gone through, had there been an Indian bank willing to provide buyer credit. "The bank we approached just denied our request. There is a total lack of confidence in the banking system from within," explains a company source.
With buyers constrained on the banking side, Kapadia believes the situation will only change once more banks come into the trade markets and liquidity increases. In the meantime he advises both buyers and suppliers to structure their deals well. "Make sure you work on transactions where you are comfortable with the parameters and mitigate the risk as necessary," he says.
Shloka Nath and Ashish Kumar Mishra are Senior Features Writers with the new business magazine to be launched by Network 18 in alliance with Forbes of USA
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