Banning of letters of undertaking (LoUs) and letters of comfort (LoCs) by the RBI as trade finance instruments is likely to reduce financial flexibility of importers.
In the wake of Rs 13,000-crore PNB scam by diamond jewellery designer Nirav Modi and his associates through fraudulent LoUs, the central bank stopped banks from issuing the two instruments for trade credits for imports into India.
The Reserve Bank of India’s (RBI) decision to ban LoUs and LoCs as trade finance instruments is likely to limit the overall financial flexibility of Indian importers.
The curb on the mobilisation of foreign currency working capital funds is likely to translate into liquidity pressure and higher funding costs for small and medium-sized corporate in short term.
Meanwhile, the impact on large-sized (revenue above Rs 7.5 billion) players is likely to be lower.
Ind-Ra opines that funding costs for projects where a substantial portion of plant and machinery is required to be imported may witness an increase in finance cost in initial years, thereby increasing the pressure on project returns.
The recent ban on LoUs by the RBI may pose challenges to banks to provide necessary support to importers.
As a result, it is said they are likely to report an increase in net working capital requirements, exerting further pressure on their liquidity profiles and, thus, increasing their fund-based limit utilisation or their need to seek additional limits. Ban of LoUs is a major challenge that importers will have to face as most of their business will get affected profusely.
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