A fresh lease of life to Trade Credits Business

The banking regular in India has issued revised framework on trade credits policy on March 13, 2019. Trade credits is kind of financing in foreign currency provided by foreign banks, financial institutions, supplier of goods, and other permitted lenders for import of capital and non capital goods in India. These include supplier’s credit and buyer’s credit from recognized lenders. Such financing can be also availed from foreign branches/subsidiaries of Indian banks. In fact, TCs have been one of the important business segments for them.

Trade credits have importance in India considering their benefit as low cost of finance as compared to high cost Rupee debt prevailing in the country. From WC finance angle, TCs have much wider impact on this front. Not only the costing but also depending on the operating cycle of the borrower, TCs have helped in managing cash flows to the companies.

TCs had came into negative news about an year back when the firms of diamond merchant misused the system and created a big scam forcing the regulator discontinuing (in fact exactly one year back on March 13, 2018 !) the LoU/LoC facility from Indian banks for supporting the TCs.  LoUc/LoCs are the kind of foreign bank guarantees extended by Indian lenders in favour of overseas lenders providing the TCs. The comfort of such guarantees from Indian banks, made life easy for Indian firms in raising low cost financing in the form of TCs in quickest of time.

TCs can be availed for import of non capital goods and the tenor permissible is upto one year (three years for shipyards/ship builders) or operating cycle of the borrower, whichever is less. This has huge bearing on the Indian firms operating in globalized world having severe competition on cost and margin fronts. Before the ban on LoU/LoCs, Indian firms were considering the global markets for sourcing of raw materials due to availability of cheap TCs based on LoU/LoC support. The ban in March 2018 closed this door since without LoU/LoC it was not possible for most of the mid/small size Indian firms to avail TCs. 

The external debt of the country as on September 2018 reduced from USD 529 bn of March 2018 to USD 510 billion, of which USD 104 billion was related to short term trade credits. This reflects the magnitude TCs carry on Indian financial markets. Exports of the country in FY 2019 till January are estimated to be USD 440 bn against the imports of USD 531 bn during the same period. Therefore, the country needs to facilitate competitive global financing environment to its industries in order to achieve exports outpacing imports.

In a positive move, the regulator has also increased the limit under automatic route for availing TCs from USD 20 per transaction to USD 50 mn. In fact, the limit under automatic route has been substantially increased to USD 150 mn for specific sector viz.oil/gas refining & mining, airline and shipping companies. This is supportive action and will benefit industries in reducing the procedural time in availing TCs. Although regulator as reduced the ‘All In Cost’ ceiling from Benchmark rate plus 350 bps to Benchmark rate plus 250 which may make TCs less attractive to lenders. The maximum allowed period of TCs for capital goods has been also reduced from five years to three years.  

While TCs provide advantage of low cost of finance, these instruments are also like a double edge sword and can be detrimental if not handled aptly. These instruments carry foreign exchange risks. Many Indian firms have burnt their fingers in the past and some have been completely devastated by unhedged foreign currency exposures. The ECB guidelines also stipulate that firms raising TCs are required to follow the guidelines for hedging with a board approved risk management policy. Therefore, while regulator has reopened the TCBG gate, the borrowers will also need to be alert in managing unhedged risks.

It will take some time to see positive impact of regulator’s move on TCs since most of Indian lenders had cancelled the sanctioned BG lines for availing TCs post ban of March 2018. The lenders would need to reassess borrowers and sanction fresh lines for such TC BGs. Bearing the past mistakes and diamond merchant fiasco in mind, the lenders are expected to tread cautiously this time. Events like NBFC liquidity crisis, increasing defaults in loans against pledged shares etc. are keeping the mood of corporate lending market as sombre. However, over cautious approach under the shadow of high level of NPAs and diminishing confidence in external credit ratings would not be good for industries. The regulator has done its job for supporting industries, now its turn for lenders to believe in Confucius saying that our greatest glory is not in never falling, but in rising every time we fall. 

Disclaimer: The views expressed in the article above are personal views of the author and should not be thought to represent official views, ideas, or policies of any agency or institution.

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