Onur SAKA 7/28/11

Oil Trade between India and Iran cut due to L/C absence The Indian oil imports from Iran seem to be cut nowadays due to Letter of Credit (L/C) problems. According to latest news, The State Bank of India (SBI), countrys largest lender, is not opening Letters of Credit for Iran crude oil payment due to uncertainty over payment mechanism. Before that Reserve Bank of India abolished a regional payment mechanism for Iranian crude imports, they all seem to be afraid of U.S. sanctions for facilitating payments for Iranian imports. Oil imports are probably the most remarkable transactions in international business, in which a single purchase or order may account for a billion dollars. And also, oil is a substantial resource for numerous industry and inevitable for todays transportation all over the world. So its importance for nations economies and businesses is obvious, the abolishment of L/C issuing by State Bank of India is crucial for every industry in India in addition to the economy and Indian oil importers. Can they pay with other instruments? Sure. There are several payment methods in international business, such as the ancient trade-offs, the good old cash, open account agreements, drafts, wires, credit card and etc. One part of these payment methods is too risky for the importer; he or she can make the payment directly in seconds to the exporter by wiring money, giving a sight draft or paying in cash prior to the delivery of the goods, but the chance the get them depends on the seller. Tough a solid contract of sales would prevent both parties in case of such problems; the burden of pushing the decision making mechanisms workand the difficulty of enforcing a possible in favor decision to get the payment is all up to the importer. The other part of the payment methods such as open account and time drafts are too risky for the exporter; he or she may never know the trust lying under the open account will keep on, or the importer will honor the draft. These risks will not necessarily require avoiding using them, plus the cost of the L/Cs are a little bit high for some business people, in conclusion they are used in a significant amount of world trade. Unfortunately, they cause a significant amount of disputes. In the case of Indian oil importers it is clear that even L/Cs could not prevent the problems. It is said that one cargo of Hindustan Petroleum Corporation Ltd (HPCL) and one cargo of Mangalore Refinery and Petrochemicals Ltd (MRPL) are stuck in the absence of a letter of credit from SBI. For instance, a cargo for MRPL is to be loaded in Iran today but the delivery is uncertain as the company has not been able to provide a letter of credit to the National Iranian Oil Company (NIOC). These importers have the rights to choose different payment methods unless the trade from Iran is outlawed totally by the Indian law makers. But it seems the L/C is an inevitable payment method for them. In general meaning, a letter of credit is a document issued mostly by a financial institution (a bank), used primarily in trade finance, which usually provides an irrevocable payment undertaking. It is pure payment method, in other words it is only to regulate the payment stage. (A solid-detailed contract, Incoterms and honesty are always necessary.)For a L/C to work, the importer applies a bank (issuing bank) to open a L/C, and he or she lists the required documents to the payment go through the exporter. After the issuing bank issues the letter of credit, it contacts with an advising bank in the exporters location. The advising bank contacts with the exporter and states the required documents to be provided in order to get the payment. In other words, the banks become intermediary player for payment in the international trade where the importer and exporter may never see each other. When the exporter ships the cargo and provides the required documents such as commercial invoice, packing list, onboard bill of lading, marine insurance and inspection documents. In L/C, these documents act as a proof for the shipment of agreed and proper goods, where the issuing bank is the warrantor of payment. The importer relies on the documents submitted that the goods will arrive in desired terms, and the exporter gets paid once the documents submitted.

A L/C is not a risk-free transaction because; the payment depends on the issuing bank. The advising bank is not obligated to make the payment to the exporter. On the other hand, in a confirmed L/C the advising bank may confirm the L/C or there may be a separate confirming bank; which means the confirming bank is obligated to make the payment. Modern history has lots of examples of bank failures; a not so credible bank or say an unrecognized bank from a 3rd world country may cause a problem for the exporter. But, in case of a trustworthy, creditable and world-known confirming bank, the L/C can be considered as risk-free. These features make letters of credits inevitable for international trade. The problem between the Indian oil importers and Iran is actually a problem with the Indian government; the Indian importers and Iranian exporters conduct their trade and make their L/Cs work without a problem over a long time. Since there is still not a complete global-trade regulation mechanism, international trade is exposed to political risks in addition to financial risks. Although the Indian oil importers make the best contracts of sales and clearly satisfied the L/Cs, they are exposed such political risks, If the Indian government embargoes Iran, the trade between will never work no matter what the payment method is.

Onur SAKA 7/28/11, Los Angeles