LoU ban to hit small & medium importers with higher funding costs: Report

The financial flexibility of Indian importers will be limited, leading to liquidity pressure and higher funding costs for small and medium enterprises, as a result of the ban on bank issue of letters of undertaking (LoUs) and letters of comfort (LCs), says India Ratings and Research (Ind-Ra) .
 
The Reserve Bank of India on March 14 issued the order in the wake of fraudulent LoUs issued by a public sector bank on behalf of diamond tycoons Nirav Modi and Mehul Choksi.
 
Total buyer credit for the top 160 importers was Rs 331 billion in 2016-17, of which Rs 312 billion was to large importers. Small- and medium-sized ones got only Rs 19 billion.

 

Aggregate interest coverage, says the Ind-Ra study, would contract for small and medium-sized importers by 0.75 to one times, from 3.85 times earlier. For large-sized ones, by 0.41 times, from 4.03 times.
 
Importers have historically relied on buyer credit and other such instruments for working capital. These would often be structured to allow an importer with LC/LoU dues to convert these into buyer credit, thereby receiving an extension on their credit limits at lower cost, states the report.
  
The ban on LoUs will pose a challenge to banks that provide necessary support to importers, says Ind-Ra, with importers likely to report higher net working capital requirements and raising their funds-based limit utilisation. At a time when they are already facing issues due to non-availability of these instruments for trade credit, exerting pressure on their liquidity.

 
Entrenched and creditworthy companies can get alternative financing, but small- and medium-sized ones will lose as access to lower cost foreign currency dries.
 
Traditionally, cash conversion cycles for importers were reliant on low-cost credit facilities. Revenue and profit margins of importers will be affected, say Arindam Som and Soumyajit Niyogi of Ind-Ra.
 
For 2016-17, estimated Ind-Ra, the top 160 importers had debt of Rs 3.59 trillion, of which small- and medium-sized ones accounted for less than 5 per cent.
 
The higher cost of trade finance will translate into weaker competition for imported products, says the report. Further, the profitability of large-sized importers will be negatively affected and their debt servicing ability also constrained as a result of this ban. A large proportion of importers of capital goods, for example, would have to increase their reliance on rupee-dominated borrowing. 

 
Large-sized importers generally have strong credit records, unhindered market position, and financial flexibility. Those operating in fragmented markets with a large number of small- and medium-sized companies, as in the gems and jewellery industry, will be the most affected.