Until recently, the Indian foreign exchange regulations did not offer an option for Indian exporters to receive long-term advances from foreign buyers. Exporters seeking advanced payments for supply orders exceeding a one-year delivery schedule required the prior approval of the Reserve Bank of India (RBI). On May 21 2014, in an attempt to boost exports, the RBI issued a circular permitting certain categories of exporter to receive long-term export advances up to a maximum of 10 years, to be offset against the execution of long-term supply contracts. The RBI also permitted Indian banks to issue export performance bank guarantees and standby letters of credit to guarantee the performance obligations of exporters for terms not to exceed two years (these can be rolled over for additional two-year terms, subject to the satisfaction of the bank of export's performance obligations under the supply contract with the buyer).
Under the May 2014 circular, authorised dealer banks (ie, banks that have an RBI-issued special licence) were permitted to allow Indian exporters to avail of advances against export supply contracts as long as the following conditions were met:
- The Indian exporter provided a track record of its activities for at least three years.
- All advance amounts obtained were adjusted only against future exports.
- The rate of interest payable was capped at the London Interbank Offered Rate (LIBOR), plus 200 basis points.
- Advance amounts that were not used to repay international normalised ratio loans were classified as non-performing assets.
The RBI imposed LIBOR plus a 200 basis points cap on interest rates for advances against exports. However, under the external commercial borrowing regulations (which govern all other borrowings in foreign exchange by Indian companies), the rate of interest is capped as follows:
- Loans with an average maturity of three to five years – LIBOR, plus 350 basis points.
- Loans with an average maturity of more than five years – LIBOR, plus 500 basis points.
On the strength of the May 2014 circular, several Indian exporters availed of, or sought to avail of, advances against long-term export obligations from foreign buyers. In almost all cases, these advances were extended against the credit support of export performance bank guarantees or standby letters of credit issued by an Indian authorised dealer bank (guarantor).
Several Indian exporters used these advance amounts to repay rupee-denominated loans obtained from domestic lenders. This was permissible under the May 2014 circular, as it prohibited only the repayment of rupee loans (from export advance amounts) that had been classified as non-performing loans. The repayment of existing loan accounts was deemed permissible by the RBI. This was a departure from the existing external commercial borrowing regulations (governing all other borrowings in foreign exchange by Indian companies), which do not generally permit refinancing of rupee loans out of proceeds received from a foreign currency loan.
On April 6 2015 the RBI issued a follow-on circular (the April 2015 circular) clarifying two key aspects of the advances against export performance scheme. The RBI emphasised that all export performance bank guarantees and standby letters of credit issued as credit support for advances against exports under the May 2014 circular must be in the nature of performance guarantees and may not contain clauses that could allow them to be used as financial guarantees or stand-by letters of credit.
The RBI also noted that the long-term export advance scheme was primarily being used to refinance rupee loans, instead of to execute long-term supply contracts for supply of goods. As a response to this practice, the April 2015 circular states that while the refinancing of rupee loans is permitted out of long-term export advances, in relation to export advances that are obtained from lenders that are part of the Indian banking system(1) or with the support of export performance bank guarantees or standby letters of credit from the Indian banking system, the refinanced account of the Indian exporter will be treated as restructuring (and classified as such by the relevant Indian bank) in all cases where the export advances are extended to an exporter that is in financial difficulties and uses concessions that the bank would not otherwise consider.
The RBI has set out a non-exhaustive list of signs of financial difficulty, including several soft indicators:
- repeated delays in payment of principal and interest;
- continuing inability to adhere to financial covenants;
- failure to pay statutory liabilities or utility bills; and
- delay in publication of financial statements or excessively qualified financial statements.
The May 2014 circular created an opportunity for Indian exporters to obtain foreign currency financing against performance of export supply contracts at rates lower than those available under general foreign currency borrowing. However, the April 2015 circular has made lenders and exporters reconsider the viability of the scheme. This is because most exporters were using this financing option to repay rupee loans. However, Indian banks will not be inclined to refinance rupee loans out of long-term export advances where the Indian exporter may be considered to be in financial difficulties due to the onerous provisioning norms with which they must comply. The fact that 'financial difficulties' have been defined relatively broadly by the RBI only compounds this concern.
Further, some banks are strictly interpreting the RBI's emphasis on export performance bank guarantees being purely performance based, requiring the exclusion of standard financial linked parameters and covenants from advance supply contracts before agreeing to issue an export performance bank guarantee. This could result in buyers finding the ultimate terms of export performance bank guarantees to be commercially unviable.
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