RBI moves in to plug misuse of export credit

In an effort to check the misuse of export credit by small exporters who benefit from the interest rate arbitrage between low-interest currencies and the Indian rupee, the Reserve Bank of India (RBI) has asked banks to ensure that the Foreign Exchange Management Act (FEMA) regulations are not violated during such transactions.

An RBI directive has asked banks to be careful in giving guarantees against export advances and has told them to verify the exporter's record to assess his ability to execute such orders.

Many exporters with low export turnover were receiving large amounts as export advances in currencies with lower interest rates against domestic bank guarantees, the RBI said. The exporters were depositing such advances with banks in Indian rupee to take advantage of the interest rate arbitrage, the RBI added.

Further, the guarantees were being issued even before the advances were received, with a condition that they would be operational only after getting the funds, the RBI said. The guarantees are issued at par value, against the discounted values of the export advances.

The exporters had also been allowed to freely book, cancel and rebook forward contracts without any crystallised exports and past performances, which was in violation of the FEMA regulations, the RBI said.

The exporters keep a substantial part of their Indian rupee"�US dollar leg of the currency exposure open, exposing both the exporters and the domestic banks to foreign exchange risks.

In such cases, generally, no exports have taken place and the exporters lack the ability to execute such large export orders.

These transactions have been designed take advantage of the interest rate differential and the currency movements. This has implications for capital flows.