The Reserve Bank of India (RBI) has decided to allow jewellery manufacturers supplying the domestic market to obtain loans using letters of credit (L/Cs) or bank guarantees to import gold. Such loans have until now been restricted to manufacturers of jewellery for export.

The relaxation of the rules on the use of L/Cs in gold transactions appears to reflect an easing of fears over a once too common practice involving gold dealers' arbitrage between subsidised credit rates for bullion imports and local interest rates.

Strict requirements

The RBI has nominated those banks allowed to make the loans to manufacturers of jewellery for the domestic market.

The banks must however subject the loans to capital adequacy scrutiny and ensure that the loans are being used for the purpose for which they are obtained.

L/C or guarantee

Nominated banks can extend loans to domestic jewellery manufacturers by accepting stand-by L/Cs or bank guarantees issued by their bankers in favour of the nominated banks.

Issuing banks must ensure that adequate margin is available and standby L/Cs and bank guarantees must be denominated in local not foreign currency.

Gold rate link

The exposure assumed by the nominated bank extending the loan against the standby LC or bank guarantee of another bank will be deemed as an exposure on the guaranteeing bank and will attract a risk premium to reflect this arrangement.

The tenor of loans will not exceed 90 days and interest charged to borrowers will be linked to the international gold interest rate.

Fears easing

India has been concerned in recent years about the use of L/Cs in gold deals where 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.

Dealers had 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. (DC World News, 23 July 2004).

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