Flow Of Trade Credit Influenced By Both Demand And Supply Side Factors

The Reserve Bank of India yesterday placed on its website a Working Paper titled "Cross-border Trade Credit: A Post-Crisis Empirical Analysis for India" under the Reserve Bank of India Working Paper Series. The Paper is authored by Rajeev Jain, Dhirendra Gajbhiye and Soumasree Tewari. The paper profiles trade credit extended by domestic and foreign banks to Indian importers by focusing on its size, composition and cost pattern. Using a panel data of 55 banks for 2007-08:Q1 to 2016-17:Q4, the paper finds that both demand and supply-side factors influence the flow of trade credit. The paper suggests that higher imports - whether due to high prices or volumes - lead to an increase in trade credit. From the supply-side perspective, financial health of banks, cost of trade credit and size of their overseas network seem to influence their trade credit operations. The empirical findings of the paper suggest that the banks need to expand their global banking relationship and shift towards the use of globally accepted trade finance instruments instead of indigenous instruments (i.e., LoUs /LoCs) which, however, may push up the cost.

The paper concludes the fall in trade finance intensity in recent years is clearly an indication of supply-side constraints. In particular, the financial health and size of overseas network of banks operating in India matter for trade credit. Empirical evidence suggesting positive impact of imports volume on trade credit flows makes short-term external debt as one of the critical variables to be monitored for external sector vulnerability. This is Especially pertinent when imports payments are driven by higher international commodity prices. As tight global financial conditions are found to impede trade credit flows, policy efforts towards strengthening of banks' overseas business network may make these flows more resilient.

Domestic banks largely depend on their own branches or branches/subsidiaries of other domestic banks which hitherto have been accepting non-standardised trade instruments, viz., LoUs and LoCs for arranging the trade credit. The overdependence of domestic banks on their overseas branches through less standardised trade credit instruments limits the scope of their trade credit operations. Incidentally, the drying up of trade credit disbursed through domestic banks in the aftermath of prohibition of LoUs/LoCs by the Reserve Bank of India in March 2018 confirms that their narrow overseas network base is a binding constraint for their trade credit business.

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