Absence of timely intervention by the Reserve Bank of India — coupled with imprudent conduct of commercial banks — may have caused the ongoing volatility in the forex market. This is a question that Indore-based financial analyst and long-time RBI watcher Mahesh Natani has raised as he points to an additional looming currency crisis on account of roughly $92.5 billion of trade credit (consisting of buyer’s credit and foreign letters of credit) outstanding for all commercial banks, with $73.5 billion due for repayment over the next few months.

Mr. Natani had played a key role — through the filing of a PIL in 2007 against the RBI and the Finance Ministry — in forcing the central bank to issue circulars to all commercial banks in April 2009 to compute interest on saving accounts on the basis of daily balance. With the change in the method of interest calculation, around 6-crore saving account holders are now earning an additional interest of around Rs. 10,000 crore on their deposits.

Of total external debt of roughly $390 billion as of December 31, 2012, India’s trade debts accounted for 24 per cent or roughly $92.5 billion. The SBI, in response to queries raised under the RTI, claims that it has outstanding letters of credit of roughly $21 billion. This data is corroborated from the RBI’s website in which total external debts are listed at $390 billion, of which, trade credits are roughly $95 billion. These trade credits comprise mainly short-term credit by way of foreign letters of credit and buyer’s credit.

Mr. Natani told The Hindu that a study of recent movement on the rupee-dollar front reveals the strong likelihood that most of these buyer’s credits have not been hedged by importers, which makes them and the economy even more vulnerable to persistent forex fluctuations. “The fall in the value of the dollar from Rs. 68.35 to Rs 63.35 during the last 7 days has been unnatural because oil companies are not participating in the forex market. They are getting their weekly requirement of roughly $4 billion directly from the RBI.

The slip up by the RBI and Indian banks is that they allowed Indian importers importing goods on the basis of letters of credit to be replaced by buyer’s credit of 3-6 months at an interest cost of just 6 per cent against 12.5 per cent payable on working capital limit, to be borne by the importer if the bank debits his account for the payment of the foreign letter of credit. Hedging the buyer’s credit — which entails annual hedging charges of 6 per cent — would have made overseas buyers credit unattractive for importers by doing away with the huge 6.5 per cent arbitrage in interest rates. Replacement of letters of credit by buyer’s credit also allows postponement of import payments in foreign currencies. “The RBI has permitted this postponement for a period of 360 days for reasons best known to it,” says Mr. Natani.

Importers who had availed themselves of buyer’s credit in April 2013 when the dollar was at Rs. 54 panicked when the rupee fell 14% to Rs. 62 on August 16, 2013 and rushed to hedge their buyer’s credit. “This led to the further depreciation of the rupee to Rs. 68.85 on August 28, 2013. The manner in which the rupee depreciated by over 11% in a short span of 12 days (from 16.08.2013 to 28.08.2013) shows that a major component of buyer’s credit has not been hedged by importers,” alleges Mr. Natani.

In response to queries raised by Mr. Natani under the RTI Act, the RBI has admitted that it does not possess key details on buyer’s credit being availed by importers like the amount and date of maturity.

When asked, the RBI did not respond to a detailed set of questions emailed by The Hindu on September 3, 2013.

India’s largest commercial bank, the SBI has indicated to Mr. Natani, that outstanding foreign letters of credit as of June 30, 2013 totalled Rs. 1,22,108 crore ($18.5 billion), of which Rs. 97,170 crore (roughly $14.7 billion) are due for payment on September 30, 2013. According to Mr. Natani, since the SBI accounts for roughly 20% of the entire banking business in India, this translates into total outstanding letters of credit of roughly Rs. 6,10,500 crore or $92.5 billion ($18.5 billion x 5), of which roughly $73.50 billion would be due for hedging in the next couple of months.

“If fears of a further rupee depreciation prompts even 50% of the importers not to replace their existing buyer’s credit on maturity with a fresh buyers credit, this could lead to a big deficit of roughly $45 billion in foreign trade credits which is one of the key sources of funding the current account deficit,” Mr. Natani said.

Supporting Mr. Natani’s premise, K.N. Dey, a Mumbai-based Forex Analyst, pointed out that, “An RBI notification of July had said buyer’s credit should not exceed the business cycle. Some importers used to avail buyer’s credit more than the required period of their business cycle in order to avail low cost funds. Most of the buyer’s credit remains uncovered, which resulted in huge exchange rate loss to the importers when the rupee fell from 53.50 per dollar to 68.85 per dollar last month.”

According to Mr, Dey, banks have since become very strict on hedging of buyer’s credit, further moving the buyer’s credit limit from non fund based to fund based — which needs 100 per cent collaterals.

Abhishek Goenka, Founder and CEO, India Forex Advisors, agrees. “Importers were addicted to buyer’s credit to take advantage of cheap funding, interest rate arbitrage and higher returns derived from other asset classes and used this for their largely speculative investments,” he said.

“When the markets moved beyond their expectations, roughly 80 to 90 per cent of importers were trapped. Importers who had taken buyer’s credit in 2011 and rolled it over continuously, incurred losses of over 30 per cent. Buyer’s credit is a short-term external dollar debt, an unfavourable liability for the country. A short-term credit of $96 billion is maturing by March 2014. This liability is increasing year-on-year and exerting pressure on the rupee,” he added.

(With inputs from Oommen Ninan in Mumbai)

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