The $85 billion buyers credit market has come to a standstill after the Reserve Bank of India banned banks from issuing Letters of Undertaking in the wake of the $2 billion scam at state-run Punjab National Bank.
The RBI’s decision evoked strong reaction from traders and trade bodies stating that big importers and exporters will suffer at the absence of this cheaper financial instrument. Many exporters import raw materials and availed LoUs and increase in their cost will impact their competitiveness.
“A lot of people especially genuine businessmen will be impacted and the ban is not exactly the proper thing to do” said Rajesh Mehta, Chairman, Rajesh Exports Ltd, one of India’s largest bullion exporters said.
He said the cost for trade will go up as LoU was a simple method to avail international trade finance. LoUs are the cheapest source of funding as it is prices 20-30 bps above the LIBOR, typically three or six month. The total cost is around 2.3% which is much lower than any rupee loan product which are over 9%. Since LoU route is no longer, importers have to take bank guarantees or letter of credit which are expensive.
In a statement industry body CII, termed the central bank’s decision as disruptive.
“The decision would have a disruptive impact on the buyers’ credit market, in the immediate term. The traders who have been conducting business through these instruments will now have to necessarily shift their transactions to Letters of Credit and Bank Guarantees. The result would be that cost of credit may go up, especially for the SMEs,” Shobana Kamineni, President of CII said.
Industry bodies have said that Gems and Jewellery sector will face the heat following the LoU ban
ASSOCHAM secretary general D.S. Rawat said soon after the ban importers were not able to raise money to get their shipments, essentially in the gems and jewellery trade.
“The costs have gone up since raising money through the LoU was the cheapest source of raising finance. We had a product which was an important instrument of trade finance, particularly for import based exporters; so, if a few black sheep have taken advantage of the situation, the fault does not lie with the LoU,” Mr Rawat said.
Vinay Sharma, Chairman, Export Promotion Council of EoUs and SEZs which has 5000 members also said the gem and jewellery sector will be affected the most because they import heavily to carry out business and avail LoU facility. “Our members had called up stating that they are carrying out the impact assessment and will revert back,” he said.
