Ban on LoUs to Affect Financial Flexibility of Small & Medium-Sized Importers

The Reserve Bank of India's (RBI) decision to ban letters of undertaking (LoUs) and letters of comfort (LoCs) as trade finance instruments is likely to limit the overall financial flexibility of Indian importers, says India Ratings and Research (Ind-Ra). The recent ban on LoUs by the RBI may pose challenges to banks to provide necessary support to importers, believes Ind-Ra. Moreover, various importers are facing challenges in availing LCs for availing trade credit. As a result, 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. 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 corporates in the short term. Meanwhile, the impact on large-sized (revenue above INR7.5 billion) players is likely to be lower.

Therefore, Ind-Ra expects the aggregate interest coverage of the top 160 importers by import value that avail buyer's credit to contract by about 0.41x (from 4.03x). According to the agency, the impact is likely to be more significant for small players (annual revenue below INR2.5 billion) and medium-sized players (annual revenue between INR2.5 billion and INR7.5 billion), the aggregate interest coverage of which is likely to contract by 0.75x-1.00x (from 3.85x).

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 exacerbating the pressure on project returns.

Well-entrenched and creditworthy players are likely to be able to secure alternative financing arrangements. However, access to low-cost foreign currency funding by small players and medium-sized players is likely to be impacted.

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