Indian banks reluctant to extend LCs to Sri Lanka

COLOMBO (News 1st); Several Indian banks have reduced discounting letters of credit (LCs) and have turned cautious and selective about their exposures to the island nation, reports The Economic Times.

Letters of Credit, which is a payment mechanism used in international trade to provide an economic guarantee from a creditworthy bank to an exporter of goods, is the basic instrument for financing trade between nations and banks. They are issued by many Sri Lankan lenders while others give credit to exporters based on the standing of the party, amount, the tenor of the credit, and standing of the bank issuing LCs.

Given the long trade relations, Sri Lanka's dependence on imports and expectations of credit lines (from India and other countries), and possible currency arrangements, bankers hope that the country would be able to tide over the crisis in the medium term.

However, at the beginning of December, Sri Lanka's forex reserves were just enough for a month of imports.

A senior official of the State Bank of India, which is the country's largest lender, speaking to The Economic Times stated that they have not placed a complete embargo on discounting export bills to Sri Lanka, however it is done on the basis of limits available with LC issuing banks.

Among other Indian banks, HDFC Bank has been going slow on handling LCs for exports to Sri Lanka, Axis Bank, which had financed many Indian companies with exports to Sri Lanka is being selective, while ICICI Bank has cut limits for Sri Lanka along with some of the other smaller countries for quite some time.

An official of the IndusInd Bank stated that it is closely monitoring the developments and has been selective in the transactions undertaken.

"There is nothing wrong with banks in Sri Lanka. But when the payment falls due, there may not be enough dollars available in the forex market there," said a banker to The Economic Times.

India's total exports to Sri Lanka was $3.2 billion in 2020. Oil, ships, boats, pharmaceutical products, sugar, iron and steel, cotton and machinery were the main items among exports.

Under the normal trade finance arrangement, an exporter is paid by its bank which discounts the bill after documents like shipping bills, commercial invoices, and bills of lading are submitted to the bank. The bank is paid after a certain time - the credit period which could be up to six months (or a year or more for capital goods) - by the importers' (Sri Lankan) banks.

The Economic Times further goes onto say that banks discounting bills have turned edgy as Sri Lanka is starved of dollars and

the Sri Lankan central bank may not be in a position to supply dollars when importers' banks have to make payments to exporters' banks in India.

Payments against sight bills, where (under normal circumstances) funds are transferred within five working days, are taking more than a month, said an official with a leading export promotion organization. Some exporters, said an official of a consumer goods company, are giving 6 to 7-month lines of credit to distributors who undertake exports to Sri Lanka.

Though large MNC banks like HSBC, Citi, and Standard Chartered, which have a long presence in Sri Lanka, continue to extend trade finance with certain precautions, they have the comfort of dealing with their respective Lanka office as the counterparty.

"Some banks are simply not giving any credit, but are simply operating on a collection basis. They are releasing money only after receiving it from the bank in Sri Lanka," said a mid-sized exporter.

Banks as well as Indian exporters are awaiting the $1.5 billion line of credit. Of this, it is understood that a $500 million line would be issued by Exim Bank of India to Sri Lanka very soon. "Negotiations are on between India and Sri Lanka over how the money would be used. In all likelihood, the use could be restricted to import of oil and other essentials by Lanka," said a banker.

Exim Bank has so far extended 11 credit lines to Sri Lanka aggregating to over $2.12 billion.

Another person, speaking to The Economic Times stated that Sri Lanka and India can implement an agreement that already exists between India and Nepal, which Indian tourists being allowed to spend Indian Rupees in Sri Lanka, which would ensure a supply of rupees that could be utilized to purchase goods from India. 

"But this may have central banking and regulatory implications and can be put in place only after the pandemic is over and travel restrictions are lifted," they added.