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The Indian central bank’s fiat late Tuesday asking banks to stop issuing letters of undertaking (LoU) to customers could claim an unlikely victim: The rupee.
In the absence of the LoU cushion from banks, importers must now buy additional dollars in the domestic spot market, and such purchases could influence the direction of the local unit. Indeed, the rupee may quickly lose 1-1.5% in the next few trading sessions amid higher month-end dollar demand by importers.
“The scrapping of the LoU and letter of credit facilities would create additional dollar demand as importers need to cover their offshore liabilities,” said MS Gopikrishnan, head of forex, rates and credit trading at Standard Chartered Bank. “Although some of the demand will be met by financing against more closely monitored guarantees, this may take a while before the system settle. Until then, the rupee could be under pressure, and could dip as much as 1-1.5% in the coming weeks.”
On Wednesday, the rupee initially declined, losing a quarter of a percentage point against the dollar to 65.06. Later in the day, the currency recovered to close at 64.84, with currency traders attributing the mild recovery to likely inflow of overseas funds for Indian share sales.
More than 10 initial public offers (IPO) are scheduled to be sold for subscription this month.
“Corporates with overseas liabilities are showing an interest to buy the dollar in the spot market,” said Aninddya Banerjee, current analyst at Kotak Securities that advises corporates and wealthy investors. “Ahead of the year-end, importers need funds to pay for their offshore engagements. The demand for dollar is now manifest after the closure of the LoUs.”
The Reserve Bank of India (RBI) late Tuesday asked banks not to issue LoUs and letters of comfort (LoCs) – instruments regarded as bank-guarantee equivalents. The RBI move came after LoUs were manipulated to defraud Punjab National Bank of about Rs 13,000 crore.
“Importer would need three to six months to ride out the immediate impact of LoU abolition,” said KN Dey, managing partner at United Financial Consultant, which advises corporate clients with more than $10 billion overseas liabilities. “Accordingly, they need more dollars to meet their obligations, and are busy arranging new working capital.”