Policymakers need to be careful: Sanyal on LoU ban

A day after RBI banned banks from issuing LoUs, Finance Ministry's Principal Economic Advisor Sanjeev Sanyal today said no issue can be dealt in silos and policymakers have to be careful that blocking of one route does not spread to rest of the system.

The country's apex bank the RBI yesterday barred banks from issuing guarantees in the form of letters of undertaking (LoU) as it clamped down on the import financing route used by fugitive jeweller Nirav Modi and his uncle Mehul Choksi for allegedly committing India's biggest bank fraud.

Besides, it also banned issuance of letters of comfort, which, like LoUs, are used by importers to fund their overseas purchases.

Asked if the RBI decision is an overreach action, Sanyal said, "I am not in a position to comment on RBI decision they have just introduced".

"But, the general point remains that you have to take a nuanced view of these things in particular because you are not dealing with a silo system. You are dealing with inter-connected ecosystem and if you block off oxygen in one part it rapidly spreads to rest of the system.

"So, you have to take care of these things. So, while I do, not wish to comment on specific decision, this is something that policy makers have to be careful about," Sanyal said at an AIMA event here.

As a trade financing measure, overseas banks usually lend to importers based on the LoUs issued by their banks. And the raised money used in making payment to offshore suppliers in foreign currency.

The change in regulations may hit import dependent businesses and trade that are often reliant on LoUs to get bank guarantees.

Sanyal, further said, the government is carrying out some very important measures to deal with bad loans by auctioning off some big companies.

He said the more immediate thing that needs to be done to fix governance in banks is by strengthening the regulation and supervision.

"We need to do something about the board of the banks," he said, adding that the Banks Board Bureau (BBB) was a step in that direction.

BBB has been tasked to improve the governance in PSBs, help them in developing strategies and capital raising plans besides recommending selection for top posts in the state-run banks.

Sanyal further said the government is not immediately considering privatising PSU banks.

With regard to protectionist measure being taken by developed countries, Sanyal said India remains committed to a globalised system.

"Our own history should more than adequately tells us that if we overdo any import substitution or isolationist policies it always ends in tears," he said.

The US had last week imposed 25 per cent and 10 per cent import duties on steel and aluminium products, respectively.

The decision is unlikely to impact exports of these items to the US, experts said, while expressing fear that such protectionist measures would impact global trade.

Sanyal said "We need to get into a multilateral system of trading... I'm a firm believing that we will have another round of globalisation".