The Reserve Bank of India (RBI) on Tuesday discontinued issuance of letters of undertakings (LoUs) and letters of comfort (LoCs) for importers with immediate effect, in an attempt to prevent frauds such as the one allegedly carried out by jewellers Nirav Modi and Mehul Choksi. Letters of credit (LCs) and guarantees would continue to be issued like before if they meet certain criteria. Normal trade credit is unlikely be hampered. However, cost will increase for importers and a profitable business avenue for foreign branches of banks would close down, said senior bankers. Importers were raising these LoUs at a cheaper rate than what they would have done had they gone for direct dollar financing. Another issue will be that since importers will now have to buy dollars from the market, the rupee could come under pressure. The move is likely to hurt large importers severely. According to a large importer, they used to import goods taking LoUs and LoCs from banks, while subsequently discounting them in the overseas market. This was for the period of a normal business cycle (90 days). Discount rates are 40-50 basis points above London Interbank Offered Rate, or Libor. Hence, importers used to get financing at 2 per cent per annum from the overseas market. The importers would produce finished goods with the imported stuff and square off the bank loan by selling off the finished product. A corporate treasury official estimated that the LoU discount market was at about 30 per cent of the country’s total import. According to him, now business risk for importers will increase because they will need higher finance limits from banks, which banks are anyway reluctant to give. However, Ajay Sahai, director general and chief executive, Federation of Indian Exports Organisation (FIEO), said feedback from industry is that discontinuation of LoUs and LoCs will a have limited impact. These were mainly used by the gems and jewellery industry. The alternative means (LCs and bank guarantees) are available for accessing trade finance. Borrowers will have to see if the cost of accessing finance through these guarantees and letters of credit goes up.
Source: Business Standard