RBI ban on LOUs, LOCs hampers Indian polymer trade

14 March 2018 09:12 Source:ICIS News

SINGAPORE (ICIS)--A ban announced by the Reserve Bank of India (RBI) on the issuance of letters of undertaking (LOUs) and letters of comfort (LOCs) on 13 March 2018 has led to a significant slowdown in the polymers market in India, and will make trade more expensive.

With the financial year-end fast approaching on 31 March, trade in the Indian market has additionally been impacted by this ban, market sources said.

Trade in India for most commodities typically slows ahead of the year-end as funds are allocated towards annual tax payments.

Moreover, attempts to maintain lean inventories going into the new fiscal year also usually hampers business in the last month of the year, market sources said.

Several companies also looked to file year-end taxes in the wake of the goods and service tax (GST) tax regime that came into force in July last year, and hence had limited interest to buy, market players said.

This time around, the market is seeing the major impact of a ban on LOUs and LOCs as announced in an RBI directive on 13 March.

The RBI’s directive on the ban followed after it was discovered that the misuse of LOUs issued by Punjab National Bank (PNB) to Nirav Modi and Mehul Choksi of Gitanjali Gems had resulted in a bank fraud amounting to close to $2 billion.

According to market players, LOUs and LOCs are semi-guarantee tools issued by Indian banks to importers in the country.

An LOU is an undertaking by the issuing bank to pay in case of default by the one on whose behalf it was issued.

In the face of the current scam that has plagued the country, the issuing bank, PNB, has to bear the losses as other lenders had lent to Modi and Choksi based on the LOUs issued.

“Banning LOUs and LOCs is going to increase the cost of funding transactions, as it means more money has to be paid upfront now,” an Indian trader said.

According to market players, the cost of funding imports is expected to go up, as letters of credit are typically more expensive.

RBI aims to improve its due diligence when lending out trade credit moving forward, market players said.

However, this has thrown a spanner into the operations of several genuine small and medium-sized importers who heavily relied on LOUs to source polymers and other commodities, the Indian trader said.

“Imports into India are expected to be affected by this; even exports, in cases where the raw material is imported to make finished goods that are then exported,” an Indian polymer importer said.

Companies also cited working capital constraints as a result of this directive.

“Inventory management is an issue now, given that working capital is constrained,” an Indian polyethylene (PE) processor source said.

“I have been asked to cut my usual inventory by half so as to free up capital for bank payments,” the processor source said.

Market players expect the current situation to have an impact on polymer trade, but are unsure how long it will last.

Some market players were optimistic about RBI’s attempts to improve the overall financing system in India.

An Indian PE and polypropylene (PP) importer and trader was of the view that companies who were diligent and timely in their bank transactions would benefit from this.

“Our credit limits have been enhanced as we were always prompt in our dealings and payments to our bank,” the trader said.

“It is no surprise that banks have become more conservative today, but we think that transparency and timely dealings will pay off more,” the trader added.

Focus article by Veena Pathare

By Veena Pathare