India has capped the tenure at 90 days for suppliers' and buyers' credit, including the usance period of letters of credit (L/Cs) for directly imported gold.

The Reserve Bank of India (RBI) has ordered the cap in the wake of concerns about gold dealers' arbitrage between subsidised credit rates for bullion imports and local interest rates.

The central bank has also asked banks to be cautious of such deals and ensure that credit is used only for genuine purposes.

Margin differentials

Gold dealers have been arbitraging between the slimmed down margins on offer in subsidised foreign exchange loans through L/Cs for up to one year and the higher returns available on the domestic money markets.

The dealers have been obtaining L/Cs with tenures of up to one year but buying and selling gold imports locally within a few weeks. The proceeds would then be deployed in rupee deposits until repayment fell due.

Due diligence

RBI has asked all banks exercise due diligence in transactions involving gold imports. Large or abnormal increases in the volume of an importer's business should be closely examined to ensure that transactions are genuine, the bank says.

A RBI circular insists that banks must examine the credentials of the importer before opening an L/C:

"The financial standing, line of business and the net worth of the importer customer should be commensurate with the volume of business turnover. Apart from the above, in case of such transactions banks should also make discreet enquiries from other banks to assess the actual position. Further, in order to establish audit trail of import/export transactions, all documents pertaining to such transactions must be preserved for at least five years."

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.