Published 21 Apr 2021
What Is Countertrade?
Definition Of Countertrade
So far we have discussed global trade measured in dollars, euros, or other traditional currency, which is the way that everyone assumes business is conducted today. However, when we measure global trade only in terms of currency-based transactions, we omit a portion of the market known as countertrade. Countertrade is a reciprocal form of international trade in which goods or services are exchanged for other goods or services rather than money.
This is a system of trade where buyers import machinery, equipment, technology, and raw materials from foreign manufacturers on a credit basis and agree to pay back the debt with other products or labor in a given time frame. Also, countertrade is an international trading system in which governments decrease the trade deficits and an alternative means to structuring a sale between two or more countries. A large part of countertrade has involved sales of military equipment (weaponry, vehicles and installations).
In What Situations Is This Form Of Trading Used?
This type of international trade is more common among countries with limited foreign exchange or credit facilities, that lack sufficient hard currency (i.e., cash) or where other types of market trade are impossible. In developing countries, whose currency may be weak or devalued relative to another country’s currency, bartering may be the only way to trade.
In any form, countertrade provides a mechanism for countries with limited access to liquid funds to exchange goods and services with other nations. Countertrade is part of an overall import and export strategy that ensures a country with limited domestic resources has access to needed items and raw materials. Additionally, it provides the exporting nation with an opportunity to offer goods and services in a larger international market, promoting growth within its industries.
Companies that consider countertrade typically want to expand into a foreign market, increase sales, build customer and supplier relationships, and overcome liquidity challenges.
How Countertrade Works?
When an international sale takes place, it may be difficult to structure the sale through conventional means of payment. In countertrade transactions, which involve trading in goods and services as opposed to money, cash does not change hands. Goods or services are exchanged rather than currency. This is oftentimes referred to as bartering, which is the oldest type of countertrade arrangement.
Many governments reduce imbalances in trade between countries through the use of a countertrade system of international trading.
Companies that consider countertrade typically want to expand into a foreign market, increase sales, build customer and supplier relationships, and overcome liquidity challenges. With that being said, countertrade is used primarily to:
Types Of Countertrade
There are many types of countertrading. It can be classified into six broad categories: barter, buyback, clearing agreement, counterpurchase, offset and switch trading.
Barter: Bartering is the oldest and most common countertrade arrangement. It is a form of countertrade involving the direct exchange of goods and/or services for other goods and/or services, without the use of money and without the involvement of a third party. Barter is an important means of trade with countries using unconvertible currencies. For example, a bag of nuts might be exchanged for coffee beans or meat. By removing money as a medium of exchange barter makes it possible for cash-tight countries to buy and sell. Although price must be considered in any counter trade, price is only implicit at best in the case of barter. For example, Chinese coal was exchanged for the construction of a seaport by the Dutch, and Polish coal was exchanged for concerts given by a Swedish band in Poland. In these cases the agreement dealt with how many tons of coal was to be given by China and Poland rather than the actual monetary value of the construction project or concerts.
A single contract covers both flows, in its simplest form involves no cash. In practice, supply of the principal exports is often held up until sufficient revenues have been earned from the sale of bartered goods. One of the largest barter deals to date involved Occidental Petroleum Corporation's agreement to ship sulphuric acid to the former Soviet Union for ammonia urea and potash under a 2 year deal which was worth 18 billion euros. Furthermore, during negotiation stage of a barter deal, the seller must know the market price for items offered in trade. Bartered goods can range from hams to iron pellets, mineral water, furniture or olive-oil all somewhat more difficult to price and market when potential customers must be sought.
One famous example of a barter deal—that went awry—was when Pepsico Inc. signed in 1990 with the Soviet Union to double its soft drink sales there, open two dozen new bottling plants, and launch its Pizza Hut restaurants in the country's largest cities. To finance the expansion, Pepsico promised to increase its sales of Russian vodka in the United States and begin a new venture selling and leasing Soviet-built ships abroad.
Buyback (Compensation Trade): A buyback is a countertrade occurs when a firm builds a manufacturing facility in a country—or supplies technology, equipment, training, or other services to the country and agrees to take a certain percentage of the plant's output as partial payment for the contract. Example: Party A builds a salt-processing plant in Country B, providing capital to this developing nation. In return, Country B pays Party A with salt from the plant.
Unlike counterpurchase, which involves two unrelated products, the two contracts in a compensation trade are highly related. Under a separate agreement to the sale of plant or equipment, a supplier agrees to buy part of the plant’s output for a number of years. For example, a Japanese company sold sewing machines to China and received payment in the form of 300,000 pairs of pajamas. Russia welcomes buyback.
Counterpurchase (Parallel Barter): A counterpurchase refers to the sale of goods and services to a company in a foreign country by a company that promises to make a future purchase in a specified period of a specific product from the same company in that country. For example; Party A sells salt to Party B. Party A promises to make a future purchase of sugar from Party B. The goods being sold by each party are typically unrelated but may be of equivalent value. This is one if the most common forms of countertrade. Unlike bartering, exporters entering into a counterpurchase arrangement must use a trading firm to sell the goods they purchase and will not use the goods themselves.
Counterpurchase occurs when there are two contracts or a set of parallel cash sales agreements, each paid in cash. Unlike barter which is a single transaction with an exchange price only implied. A counterpurchase involves two separate transactions-each with its own cash value. A supplier sells a facility or product at a set price and orders unrelated or non-resultant products to offset the cost to the initial buyer. Thus, the buyer pays with hard currency, whereas the supplier agrees to buy certain products within a specified period. Therefore money does not need to change hands. In effect, the practice allows the original buyer to earn back the currency. GE won a contract worth $300’million to build aircraft engines for Sweden’s JAS fighters for cash only after agreeing to buy Swedish industrial products over a period of time in the same amount through a counterpurchase deal. Brazil exports vehicles, steel, and farm products to oil-producing countries from which it buys oil in return.
Clearing Agreement: A clearing agreement is clearing account barter with no currency transaction required. With a line of credit being established in the central banks of the two countries, the trade in this case is continuous, and the exchange of products between two governments is designed to achieve an agreed-on value or volume of trade tabulated or calculated in nonconvertible “clearing account units.” For example, the former Soviet Union’s rationing of hard currency limited imports and payment of copiers. Rank Xerox decided to circumvent the problem by making copiers in India for sale to the Soviets under the country’s “clearing” agreement with India. The contract set forth goods, ratio of exchange, and time length for completion. Any imbalances after the end of the year were settled by credit into the next year, acceptance of unwanted goods, payment of penalty, or hard currency payment. Although nonconvertible in theory, clearing units in practice can be sold at a discount to trading specialists who use them to buy salable products.
Offset: Agreement that a company will offset a hard - currency purchase of an unspecified product from that nation in the future. Can be explained as an agreement by one nation to buy a product from another, subject to the purchase of some or all of the components and raw materials from the buyer of the finished product, or the assembly of such product in the buyer nation. Example: Party A and Country B enter a contract where Party A agrees to buy sugar from Country B to manufacture candy. Country B then buys that candy.
This practice is common in aerospace, defense and certain infrastructure industries. Offsetting is also more common for larger, more expensive items. An offset arrangement may also be referred to as industrial participation or industrial cooperation.
Switch Trading: Defined as a practice in which one company sells to another its obligation to make a purchase in a given country. Switch trading involves a triangular rather than bilateral trade agreement. Example: Party A and Party B are countertrading salt for sugar. Party A may switch its obligation to pay Party B to a third party, known as the switch trader. The switch trader gets the sugar from Party B at a discount and sells it for money. The money is used as Party A’s payment to Party B.
When goods, all or part, from the buying country are not easily usable or salable; it may be necessary to bring in a third party to dispose of the merchandise. The third party pays hard currency for the unwanted merchandise at a considerable discount. A hypothetical example could involve Italy having a credit of $4 million for Austria’s hams, which Italy cannot use, A third-party company may decide to sell Italy some desired merchandise worth $3 million for a claim on the Austrian hams. The price differential or margin is accepted as being necessary to cover the costs of doing business this way. The company can ‘then sell the acquired hams to Switzerland for Swiss francs, which are freely convertible to dollars.
Advantages Of Countertrade
Disadvantages Of Countertrade
Role Of Countertrade In The World Market
Countertrade transactions have been basically conducted among the former Soviet Union and its allies in the Eastern Europe and other parts of the world. The reason that these countries have allocated a big portion of their commerce to the countertrade attributed to insufficient hard currency. A significant proportion of international commerce, possibly as much as 25%, involves the barter of products for other products rather than for hard currency. Countertrade may range from a simple barter between two countries to a complex web of exchanges meeting the needs of all countries involved.
The volume of countertrade is growing. In 1972, it was estimated that countertrade was used by business and governments in 15 countries; in 1979, 27 countries; by the start of the 1990s, around 100 countries. More than 80 countries nowadays regularly use or require countertrade exchanges.