Countertrade is any commercial arrangement in which sellers or exporters are required to accept in partial or total settlement of their deliveries, a supply of products from the importing country. In essence, it is a nation’s (or firm’s) use of its purchasing power as a leverage to force a private firm to purchase or market its marginally undesirable goods or exact other concessions in order to finance its imports, obtain needed hard currency or technology. Although the manner in which the transaction is structured may vary, the distinctive feature of such arrangements is the mandatory performance element that is either required by the importer, importer’s government or made necessary by competitive considerations.
The origins of countertrade can be traced to the ancient times when international trade was based on the free exchange of goods. Barter flourished in Northern Mesopotamia as early as 3000 B.C when inhabitants traded in textiles and metals. The Greeks also profited by the exchange of olive oil and wine for grain and metals sometime before 2000 BC. Even with the flourishing of a money economy, barter still continued as a medium of exchange. Present-day countertrade involves more than the use of simple barter. It is a complex transaction that includes the exchange of some currency as well as goods between two or more nations. A countertrade transaction may, for example, specify that the seller be paid in foreign currency on the condition that seller agrees to find markets for specified products from the buyer’s country.
The resurgence of countertrade has often been associated with East-West trade. At the start of the 1950s the former communist countries of Eastern Europe faced a chronic shortage of hard (convertible) currency to purchase needed imports. In their dealings with Western countries, they insisted that their products be taken in exchange for imports from the latter countries. This practice also proved quite attractive to many developing nations, which also suffer from a shortage of convertible currency.
The use of countertrade has steadily increased and is presently estimated to account for about 15 to 20 percent of world trade. Although there may be disagreements concerning the current volume of countertrade, the broad consensus is that countertrade constitutes a significant and rapidly growing portion of world commerce. A large number of U.S. corporations find it difficult to conduct business with many countries without relying on countertrade. For example, about two-thirds of foreign purchases of American commercial and military jets are paid for with local products instead of cash. In response to this growing interest, some U.S. banks have established their own countertrade departments.
The Mechanics of a Barter Transaction
Suppose a private firm is selling drilling equipment to country A in exchange for ten tons of basmati rice. One method is to use reciprocal performance guarantees such as performance bonds or standby letters of credit. Each party posts a guarantee, and this provides payment to the aggrieved party in the event of failure by the other party to perform its part of the contract (i.e., failure to deliver the goods or delivery of non-conforming goods). However, the fees charged by banks for such guarantees are quite high. Another method is to use an escrow account to secure performance of an obligation by each party. The steps used are as follows:
- The firm opens a documentary letter of credit in favor of country A. In cases where the product is passed to a trading company, the letter of credit is opened by the trading company in favor of the nation.
- Country A delivers the rice to the firm or trading company and title is transferred.
- When the title passes to the firm, funds equal to the value of the rice shipped is transferred by the firm under the letter of credit into an escrow account.
- The firm makes delivery of the drilling equipment simultaneously, or at a later date, to country A and title is transferred to the nation.
- Funds in the escrow account are released to the firm.
In the event the firm delivers non-conforming goods or fails to deliver the goods, the funds in the escrow account are paid to the nation.
Types of countertrade
- Barter: A classic barter arrangement involves the direct exchange of goods/services between two trading parties.
- Switch trading: This is an arrangement in which a switch trader will buy or market countertraded products for hard currency. The switch trader will often demand a sizable fee in the form of a discount on the goods delivered.
- Clearing arrangements: Two governments agree to purchase a certain volume of each other’s goods and/or services over a certain period of time, usually a year. Each country sets up an account in one currency, for example, clearing dollar, pound, or local currency. When a trade imbalance exists, settlement of accounts can be in the form of hard–currency payments for the shortfall, transfer of goods, issuance of a credit against the following year’s clearing arrangement, or by switch trading.
- Buyback: In a buyback or compensation transaction, a private firm will sell or license technology or build a plant (with payment in hard currency) and agree to purchase, over a given number of years, a certain proportion of the output produced from the use of the technology or plant.
- Counter-purchase: A firm sells goods and/or services to an importer, promising to purchase from the latter or other entities in the importing nation goods that are unrelated to the items sold.
- Offsets: An offset is a transaction in which an exporter allows the purchaser, generally a foreign government, to “offset’’ the cost of purchasing its (the exporter’s) product. Such arrangements are mainly used for defense-related sales, sales of commercial aircraft, or sales of other high-technology products. The offsets can take the form of sub-contractor production, joint production, technology transfer or investments.