The Reserve Bank of India's (RBI’s) decision to suspend Letters of Undertaking (LoUs) for importers cannot be treated as a solution for cleaning the trade finance system, exporters say. The move is expected to hit large exporting firms hard, they warn.
“On a review of the extant guidelines, it has been decided to discontinue the practice of issuance of Letters of Understanding/ Letters of Comfort for trade credits for imports into India by Category–I banks with immediate effect,” RBI said on Tuesday.
The trade credit instrument banned by RBI is used heavily by exporters who import goods which go into the making of export products. It had to come to light that diamond merchant Nirav Modi and his associates used the instrument to take out loans worth Rs 130 billion from public lender Punjab National Bank.
However, RBI said other instruments such as Letters of Credit and bank guarantees, the international norm, would continue to be provided by banks.
Large exporters across sectors such as gems and jewellery, heavy engineering and some others use the now-stopped mechanism heavily. As a result, export from these sectors is expected to take a dip, even as the cost of funding would rise for companies, Ganesh Kumar Gupta, president of the Federation of Indian Export Organisations, said.
Till now, public sector Category-I banks were permitted to issue guarantees/LoUs/Letters of Comfort in favour of foreign suppliers, banks or financial institutions up to $20 million per import transaction. This was valid for up to one year from the date of shipment in import of non-capital goods, excepting gold, silver and some other items. For import of capital goods, the period was a maximum of three years.
“Sourcing of trade funding has already become difficult for players in the gems and jewellery segment. It will become even more so with increasingly stringent measures being put in place,” said Praveen Shankar Pandya, former chairman of the Gems and Jewellery Export Promotion Council.
In a separate development, the Directorate General of Foreign Trade on Tuesday issued a public notice and deleted para 2.86 of the handbook of procedures in the Foreign Trade Policy 2015-20. This means status holders would no more be able to claim benefits. such as exim scrip or duty credit certificates and show fulfilment of export obligations against irrevocable letters of credit.
An official from a status holder export house said on the condition of anonymity, "DHFT’s move seems to be against those involved in round-tripping, which largely happens in the gem and jewellery sector, since it increases costs to bring back dollars for exports made. But, genuine exporters will have to suffer because of them."