Fitch group’s Ind-Ra sees short-term woes for SMEs after LoU ban by RBI

According to Fitch group company, banning of letters of understanding and letters of comfort as trade finance instruments is expected to reduce the financial flexibility of importers

Banning of letters of undertaking (LoUs) and letters of comfort (LoCs) by the Reserve Bank of India (RBI) as trade finance instruments is likely to reduce financial flexibility of importers, a Fitch group company on Tuesday said.

In the wake of Rs 13,000-crore PNB scam allegedly by diamond jewellery designer Nirav Modi and his associates through fraudulent LoUs, the central bank stopped banks from issuing the two instruments for trade credits for imports into India.

“The RBI’s decision to ban LoUs and LoCs as trade finance instruments is likely to limit the overall financial flexibility of Indian importers,” India Ratings and Research (Ind-Ra) said.

The curb on the mobilisation of foreign currency working capital funds is likely to translate into liquidity pressure and higher funding costs for small and medium-sized corporate in short term.

Meanwhile, the impact on large-sized (revenue above Rs 7.5 billion) players is likely to be lower, the Fitch group company said.

Ind-Ra opines that funding costs for projects where a substantial portion of plant and machinery is required to be imported may witness an increase in finance cost in initial years, thereby exacerbating the pressure on project returns.

“The recent ban on LoUs by the RBI may pose challenges to banks to provide necessary support to importers,” Ind-Ra said, adding that various importers are facing challenges in availing LoCs for availing trade credit.

As a result, it said that they are likely to report an increase in net working capital requirements, exerting further pressure on their liquidity profiles and, thus, increasing their fund-based limit utilisation or their need to seek additional limits.

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