3 reasons why RBI’s ban on LoUs may have disruptive impact on economy

markets, premium, forward premium, multi year lows, PNB scam The move will result in hiking working capital requirement of industries as per their trade cycle.

With an aim to prevent nearly $2 billion PNB-type frauds in future, the Reserve Bank of India (RBI) on Tuesday banned issuance of Letters of Undertaking (LoUs) for importers with an immediate effect. The Letters of Credit (LCs) will continue to be issued just like before. However, industry is not taking the decision in a positive light and consider it disruptive for economy. The ban will have disruptive impact at least in the immediate term since businesses especially small ones require higher working capital, PTI reported citing industry bodies. The move by the RBI will have a disruptive impact on the credit market of the buyers at least in the immediate term, PTI reported citing CII President Shobana Kamineni. The traders will now look towards Letters of Credit (LCs) and bank guarantees to conduct their businesses, she said.

Working capital requirement

The move will result in hiking working capital requirement of industries as per their trade cycle and will disrupt trade, services and industry, said PHD Chamber President Anil Khaitan.

Pressure on rupee

Till now, importers were raising the LoUs at a rate cheaper than the way of direct dollar financing. Now, these importers will be required to purchase dollars from the market, putting pressure on rupee.

Net Interest Income

The move by RBI may not be detrimental since LoUs are only used in jewellery sector that too by large businesses. The new regulation will pose an impact on the fees and Net Interest Income (NII) of sectors such as electronics, gems and jewellery, global brokerage CLSA said. However, the impact of the move maybe limited in the longer term, CLSA added. The businesses will now move towards other financial instruments such as letters of credit and guarantees.

The industry body Assocham has issued warning earlier this week that overreaction by lending institutions and probe agencies will hurt required credit disbursement to the trade and industry which will in turn impact growth expectations.

Source: Financial Express