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Ban on LoUs to have disruptive impact: India Inc

Thursday, March 15, 2018

Industry bodies yesterday said RBI's decision to ban Letters of Undertaking (LOUs) for trade credit for imports will have a disruptive impact, at least in the immediate term, as small businesses would require higher working capital.

In a significant development, the RBI yesterday barred banks from issuing guarantees in the form of LoUs and letters of comfort in the wake of nearly USD 2 billion scam in state-run Punjab National Bank involving jeweller Nirav Modi and his uncle Mehul Choksi. Ajay Sahai, Director General of exporters' body FIEO opined that RBI's move will have limited impact as LoUs are generally used in gems and jewellery sector and that too by large players.

In a statement, CII President Shobana Kamineni said the move would have a "disruptive impact" on the buyers' credit market, in the immediate term. "The traders who have been conducting business through these two instruments will now have to necessarily shift their transactions to Letters of Credit and bank guarantees," said Kamineni.

PHD Chamber President Anil Khaitan said banning of these instruments is not a solution to curb malpractices or scandals.

"We know that this move by RBI would result into increasing working capital requirement of industries as per their trade cycle and will disrupt trade, services and industry," said Khaitan.

"Industry, particularly MSMEs whose working capital is based as per their trade cycle, will require higher working capital or else suffer irreparable losses," he added.

While RBI has banned LoUs and letters of comfort, letters of credit and bank guarantees will remain available for trade credit.

Policymakers need to be careful: Sanyal
After RBI banned banks from issuing LoUs, Finance Ministry's Principal Economic Advisor Sanjeev Sanyal yesterday 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.

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.

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