To be geared up, the traders in the world are seriously busy in reshaping their business strategic plans. On the other hand financial sectors and Forfaiting sectors are raising their capital structure to meet the time demand financing and bills discounting.
It requires defining Forfaiting for the general readers. Forfeiting is an alternative approach to export trade finance by discounting of bills or promissory note or other evidence of debt. Switzerland and United Kingdom are the major Forfaiting markets in the world and it is growing very fast. Not only Forfeiting market even secondary Forfaiting market is growing fast that purchases the rights to recover debt from Forfaiter and becomes Forfeiter.
A manufacturing and trading business establishes on 5M. Those 5M are Money (capital investment), Manpower (skilled labour), Machine/Material, Management and Matching cost of product (Competitive price of products). 2 stands as a multiplying symbol the entrepreneur applies according to the needs of business and to compete in the market. Truly speaking small and medium-size entrepreneur generally makes his working capital plans entirely on the running finance facilities from financial institutions whereas, large businesses are planned up to 49% on gearing. In Pakistan the allowed debt-equity ratio is 60:40 under SBP prudential regulations.
Loan-based business tradition was working to an extent due to limited competitive market place. When the world will be a market place the negative effects will be realised soon. The loan-based business has negative impacts on the pricing of the goods, it raises the price of the good to the extent the entrepreneur needs to recover the cost of interest. And today the cost of interest is a combination of base Interest + Forfeiting cost + Secondary Market Forfeiting cost. Further Forfeiting cost includes Discount Rate + Commitment Fees + Option Fees and Risk Premium.
India and China will be the main competitors in the world open market because the goods they are producing cost them low due to large amount of production has huge demand in the domestic market.
The economics theory needed to be understood. At a certain number of units production the entrepreneur reaches a breakeven point and an increase from breakeven production the entrepreneur makes a planned profit on the production and an increase over profit-making point decreases the price of the unit produced. There has to be a demand to supply the production. India and China are thick populated countries so the demands of goods are enormous. Their goods prices thus are comparatively low in the world market against the same quality of goods from other countries.
WTO 2005 will eliminate the existing demand market opportunity as the entire world will be the market place for each country. The matching price to quality will be the gainer.
How Islamic finance will give an edge in the change environment? The interest-based finance increases the capacity to produce but simultaneously increases the price of the product proportionately to interest payable whereas, Islamic finance increases the capacity of production without increasing the cost of the product. Example; if in the world open market there is a demand of certain quantity of goods of certain quality and company C, I and P are producing the demanded goods. Company C and I have taken interest-based finance to purchase machine/ equipment to meet the demand of production and Company P has taken Islamic finance (Musharakah and Mudarabah). Now company C and I unit price will be direct cost + Indirect cost + Interest cost + Profit margin = sale price. Whereas P unit price will be Direct cost + Indirect cost + Profit margin = Sale price. Therefore, P will have an edge over C and I by the difference of Interest cost. This is the first segment to reduce the cost of unit price. Second segment is also there which can further reduce the cost price per unit that is cost of raw material. If the raw material is purchased on credit from supplier it will cost high as the supplier (exporter) will recover the cost of interest, including Forfeiting cost from buyer (importer). Here also the Islamic finance (for raw material purchases) will keep the cost of raw material constant. This will be second edge to Islamic finance users. To gain knowledge about Islamic Finance and Banking read my book, "model Islamic bank on Shariah percept" or discuss with an Islamic bank in the country. Ignorance would be refutation so I emphasise on exporters and importers to ask their Finance managers/directors to study the Islamic finance merits to save the company from future shocks.
Presently over 288 banks are providing Islamic finance around the world, including 24 in UK and 20 in USA and 7 in Pakistan, including Meezan Bank, Muslim Commercial Bank, Bank Al Falah, and Habib Bank AG Zurich, Islamic banking branches. Islamic methods comprehensively attend to 5M and provide equitable solutions.
As an example for understanding, suppose company C/I takes $1000,000 loan from a bank at 15% interest per annum payable in 5 instalments in five years to increase their production upto 20,000 units to meet the market demand when the world becomes open market in 2005.
We also suppose that the existing capacity of production is 10,000 units on capital investment cost of $ 1000,000 and its product sale price is $100 per unit, including 20% profit. We also suppose that after taking a loan of $1000,000 to produce 10,000 more units all elements of cost and rate of profit are the same except the cost of finance (interest). The sale price for 20,000 units, including profit, will be 2,000,000/20,000 = 100. After adding compound interest cost, the unit price will be $107.50 and for 20,000 units $2,150,000. Comparatively on the same supposition but without interest element, P cost of 20,000 units will be $2,000,000, including 20% profit. It is apparent that P will be able to capture the market being at a low price for the same quality C/I is supplying.
If P has taken Musharikah and Mudarabah (joint venture) finance from a bank on agreed distribution of profit ratio 50:50 (For bank 50% and for Mudarib (company) 50%) the company will need to give 50% of the profit the bank's capital has earned on the transaction. Suppose profit on bank's capital is $200,000 P will pay the bank a profit share of $ 100,000 and retain $ 100,000 for company, which the company can use to pay back partial capital investment of the bank.
(The writer is author of a book, "Model Islamic Bank on Shariah percept.")
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