A Ginger Exporter Chooses Between FOB and CIF
A spice trader in Nagaon, Assam, has an order for 20 tonnes of dried ginger from a buyer in Dhaka. The buyer asks for a quotation either FOB Kolkata or CIF Chittagong. The trader learns that ocean freight from Kolkata to Chittagong is $1,500 and marine insurance is $250. The ginger will be trucked from Nagaon to Kolkata, where it will be loaded on the ship. The buyer wants to pay 30 days after shipment. The trader's bank suggests a letter of credit (LC) but warns that the buyer's bank is small and the LC has two discrepancies: the shipment date and the description of goods. The trader's brother says, 'Take 50% advance and send the rest on trust; LC paperwork is trouble.' Export incentives and GST refunds are also on the trader's mind.
1. If the FOB value is $18,000, compute the CIF value. Explain who pays freight and insurance and where risk passes in each term.
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Computation. CIF value = FOB value + ocean freight + marine insurance = $18,000 + $1,500 + $250 = $19,750.
FOB Kolkata. The seller delivers the goods on board the ship at Kolkata and pays the cost of getting them there, including inland transport and export clearance. The buyer pays ocean freight and insurance. Risk passes to the buyer when the goods are placed on board the vessel at Kolkata. If the ginger is damaged after loading, the buyer bears the loss and must claim under its own insurance.
CIF Chittagong. The seller pays the cost of goods, freight to Chittagong, and insurance. But risk still passes at Kolkata when the goods are on board, not when they reach Chittagong. The seller must arrange insurance, normally for at least 110% of the contract value under CIF terms. If the goods are lost at sea, the buyer claims on the policy even though the seller paid the premium.
Judgement. The CIF quotation is $19,750, but the trader must remember that CIF is not a 'delivered' term. Risk is not shifted to the seller's account simply because he pays freight and insurance.
2. Advise on the payment method: 50% advance versus LC, considering the discrepancies and the small buyer's bank.
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50% advance. This reduces the exporter's risk because half the value is received before shipment. But the buyer may refuse, and the remaining 50% is still open to non-payment. Sending the balance 'on trust' is an open account arrangement and is risky with a new buyer in another country.
Letter of credit. An LC is a bank's undertaking to pay if the exporter presents compliant documents. It is safer than trust, but the LC must be workable. The two discrepancies are serious: if the shipment date is not amended, the exporter may ship late and the bank may refuse; if the goods description differs from the invoice and transport documents, the bank may reject the documents. The small buyer's bank also adds risk, so the exporter should confirm that the LC is advised through a reputable bank in India and is irrevocable.
Recommendation. Do not ship against a discrepant LC. Ask the buyer to amend the shipment date and the goods description before shipment. Use the LC as the main security, and if the buyer insists on a deposit, take a modest advance in addition. Keep the 50% advance idea only as a fallback. The exporter should also check whether the LC is confirmed, because confirmation by a strong bank reduces the small-issuing-bank risk.
3. Identify two documents the trader must prepare for the LC and explain why each matters. Also state how GST refunds and export incentives should influence the decision.
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Documents for the LC.
- Commercial invoice. It states the buyer and seller, goods description, quantity, unit price, Incoterm, and total value. The description must match the LC exactly; a mismatch is a discrepancy.
- Bill of lading. It is the transport document and evidence that goods were shipped on board. It shows the port of loading, port of discharge, consignee, and date of shipment. Banks check it against the LC shipment date.
The exporter may also need a packing list, certificate of origin, phytosanitary certificate, and insurance policy for CIF. Each document must be consistent with the others.
GST and incentives. Exports are generally zero-rated for GST, and the exporter can claim a refund of input tax credit or use the export route that suits the business. The trader should keep shipping bills, invoices, and bank realisation certificates. Export incentives depend on the scheme and product; they should not be assumed. The decision between FOB and CIF should be based on freight cost, insurance cost, risk, and control of documents, not only on the incentive. If the LC is discrepant and payment is delayed, the refund and incentive cash flows are also delayed, so document accuracy is part of financial management.