MUMBAI: Small and medium businesses, including those in the gems and jewellery business and other sectors, are likely to be affected by the RBI’s latest missive banning the issuance of Letter of Undertaking (LoU) for trade finance for imports into India.
Industry sources said the move could make credit expensive as related instruments like Letters of Credit and bank guarantees cost at least 0.5-1 per cent more than LoUs. Moreover, in the absence of LoUs, which are typically issued in foreign currency, traders will be compelled to borrow in rupees and pay back suppliers in foreign currency, which in turn could raise overall costs.
So far, LoUs have been predominantly used by gold and diamond traders, but the impact of scrapping these instruments could affect small and medium enterprises across all industries operating in the import-export business. The RBI is also yet to clarify if these traders can utilise LoCs or bank guarantees in instead of LoUs to conduct business.
On Tuesday the RBI decided to discontinue the practice of issuance of LoUs/LoCs for trade credits for imports by AD Category–I banks with immediate effect.
LoUs are instruments with which a bank allows customers to raise short-term foreign currency from its own or another bank’s foreign branch to repay offshore suppliers. Banks can approve trade credits for imports up to $20 million per import transaction for up to one year for non-capital goods (except gold), and up to three years for capital goods.