India's ban on lending instruments weighing on chemical markets

23 March 2018 03:25 Source:ICIS News

SINGAPORE (ICIS)--India’s ban on key lending instruments - after the swell of recent bank scams - is expected to weigh on petrochemical imports by increasing financing costs and working capital constraints, and even pose a downside risk to the country’s robust economic growth.

The announcement of the ban by the Reserve Bank of India (RBI) on the issuance of letters of undertaking (LOUs) and letters of comfort (LOCs)on 13 March this year has already slowed down the country’s polymers market.

An LOU is generally used to fund imports and to avail short-term credit. It is also an undertaking by the issuing bank to pay in case of default by the one on whose behalf it was issued.

The full impact of RBI’s ban is expected to only be significantly felt from April onwards, when India’s fiscal year starts, according to market sources.

Buyers typically look to replenish stocks in the new financial year from the second half of April onwards, and would have difficulty in concluding deals in the absence of LOUs and LOCs, an Indian polymer trader said.

The impact of this is not being felt as much in March because Indian firms are busy with their fiscal year-end annual tax formalities, especially now following the implementation of the goods and services (GST) tax regime in July last year, market sources said.

Some polymer importers were of the view that the effects of a possible blanket ban would impact demand for the whole year from April, while others were of the view that banks would still issue LOUs and LOCs but were likely to have a more thorough verification process with a possible increase in finance costs.

In the domestic toluene market, sentiment remains mixed on RBI’s ban amid squeezed margins and high shore tank inventories at west coast India ports.

Some importers were particularly cautious about buying CFR (cost & freight) India cargoes because they were worried that the government would be much stricter in regulatory checks and less lenient with payment terms and timings.

However, others were still optimistic that this would not cause a big problem in the importation of toluene cargoes since it makes up a large percentage of the country's import business.

Meanwhile, concerns are rife among some ethylene vinyl acetate (EVA) producers on the impact on the progress of payments from buyers in India but some are looking at ways to work with buyers to extend support as well as to minimize their risk exposure.

“My concern is that buyers are not going to open LCs [letter of credit] on time,” a south Korean EVA producer said.

Another producer who usually transacts with customers on an at sight or 30 days’ payment term basis added that a portion of their buyers need supplier’s support on credit.

“They request us to increase the credit terms to a minimum of 90 days…But we will find a way to match with this situation by offering our usual way and see customers’ feedback first,” he said.

“If they need more terms we will discuss on a case by case basis,” the producer added.

An Indian trader said the ban has a big impact on traders as import costs will go up.

In the solvents market, participants said the cost of imported phenol and acetone is likely to increase as Indian buyers have to extend their credit duration because it will be harder to secure cash flow from local banks.

"We have to assess the credit ratings of our Indian customers before we agree to longer LC terms and this is likely to slow trade discussion,” an international trader said.

“The big players which have healthy books are not likely to be affected by this. It’s the smaller players that are likely to find it more challenging to secure cargo," an Indian solvent buyer said.

The uncertainty over the long-term impact of the RBI ban has also crept into India’s methanol market, with prices seeing wide fluctuations since the announcement.

“Many players across the trade industry are appealing the restriction and we are uncertain if it would be lifted soon or would remain for the long term,” an Indian distributor said.

Several market players said that the ban will weigh more on smaller, less established importers with bad credit history, while the larger importers would still be able to obtain their LCs and finance their purchases.

There were also expectations that the RBI will lift the ban once they have completed their investigation into bank frauds.

The RBI’s directive on the ban came 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 $2bn.

“Recent developments in the banking sector, including stricter non-performing loan resolution processes and large-scale fraud scandals in public sector banks, pose a sizeable downside risk to growth,” said Spain-based FocusEconomics in its April consensus report for east and south Asia.

A cyclical economic recovery has taken hold as the effects of demonetisation and the GST ebb, FocusEconomics said.

This trend is seen extending into the fiscal year which runs from April 2018 to March 2019, with growth benefitting from higher public capital spending and recovering private business sentiment, the research firm said.

On the trade front, India’s imports moderated markedly in February, expanding by 10.5% year on year versus the 26.0% expansion seen in January this year.

“The external sector remains beset by uncertainty induced by the implementation of the GST, particularly exporters that continue to face delayed GST refunds due to tax filing discrepancies,” FocusEconomics said.

Similarly, the 13 March ban by the RBI could result in rising costs of financing and increased working capital constrains, it added.

Overall, recent economic indicators are suggesting that a growth recovery is well underway, while investment, particularly in infrastructure, remains, steady, Japanese brokerage Nomura said in a note.

“Extant trade risks like the approximately Rupee (Rp) 100bn of GST refunds intended for exporters that remain stuck in the system, or the RBI’s decision to ban LOUs and LOCs for trade imports worsens the outlook for the external sector,” said.”

India’s economy for the new fiscal year starting April is likely to benefit from pre-election spending and an anticipated pick-up in rural incomes, said Radhika Rao, an economist at Singapore-based DBS Group Research.

Top image: Indian rupee: (Photographer Saikat Paul/Pacific Press via ZUMA Wire/REX/Shutterstock)

With additional reporting by Veena Pathare, Trixie Yap, Yaw Min Jie, Helen Lee and Kite Chong

Focus article and interactive by Nurluqman Suratman

By Nurluqman Suratman