`NAIVE' SMEs URGED TO ASSESS PAYMENT RISKS - Brief Article

Business Asia, August, 2000

WESTPAC IS urging new exporters to properly assess the buyer, country and currency risks associated with trade with Asia to reduce the likelihood of contract and payment defaults.

"New small- to medium-sized exporters (SMEs) particularly in the fibre, computer, telco and food sectors may typically not be as aware of the risks associated with international trade as the bulk commodity, coal and wheat industries that often trade with larger co-operatives or enterprises," says Scott Henwood, Westpac's senior manager of international trade risk.

"For new exporters in this sector, it is critical they review the variety of payment methods available to hedge their risk of possible default. This could range from receiving a cash payment up-front to seeking open account credit insurance, or having their Australian bank confirming or underwriting payment."

Although rare if properly managed, Henwood says contract defaults have a serious impact on an SME's cash flow and balance sheet structures, which can in some instances have terminal consequences.

"An average A$250,000 to A$500,000 trade contract that has defaulted not only means negative cash flow for the exporter, but additional costs associated with warehousing, insuring and finding a new buyer for the goods that are now offshore," he says. "In addition, once the market in the importing country becomes aware that there are distressed goods on offer, the price is automatically pushed down."

According to Westpac's monthly indicative risk assessment, countries where there is a higher risk of defaulting payment for July include Pakistan and Indonesia.

The countries where risk is perceived as being lower are those such as Korea, Thailand and Malaysia, which have positively restructured as a result of the Asian crisis.

"Trading with a relatively risk-free country does not necessarily mean that there is no risk at all. The exporter still needs to understand the buyer's agenda, how they intend to use the product and more importantly, the terms of their contract," Henwood says. "The exporter needs to understand the credit-worthiness of the buyer, methods of transport and payment being proposed, and their driver or need for the product. History has shown that the more important the product is to the importing country's economy and continued prosperity, the less likely the chances of default in payment.

"Ideally, before negotiations are completed and the contract signed, exporters should speak to their bank to assess the country risk associated with payment, they should also seek assistance from government agencies such as the Department of Foreign Affairs and Trade (DFAT), Export Finance & Insurance Corporation (EFIC) and do their homework on the buyer," he says.

"Exporters should be aware that management of their trade risk is an ongoing process as it is highly unlikely that political, economic and financial circumstances in the country of destination will be identical at time of delivery as they were when the contract was signed."

With respect to currency risk, Henwood estimates that more than 80 per cent of large corporations but less than 55 per cent of SMEs actively manage their foreign exchange risks effectively.

"In a typical small- to medium-sized firm, currency exposures could account for up to 40 per cent of their balance sheet so it is important for exporters to become more educated about the value of effective hedging," he says.

"For a US$1 million transaction, a 5 per cent fall in the Australian dollar could result in a potential loss of $81,000 for an exporter, so exporters need to become much more sophisticated in their hedging strategies."

Westpac says exporters have three alternatives available to them to hedge their foreign exchange risk portfolios -- forward exchange contracts, currency options or "doing nothing".