LoU ban forces mobile phone makers to dial back on production plans

Nirav Modi’s $2-billion bank fraud has made life difficult for Indian mobile phone makers ever since the Reserve Bank of India imposed a blanket ban on Letters of Undertaking (LoUs), whose issuance was abused to perpetrate the scam.

LoUs, issued by domestic branches of Indian banks for customers to avail themselves of trade credit from foreign branches of other banks, were being extensively used by Indian mobile phone brands to import components from suppliers in China.

Rising cost of funds

These companies are now forced to pay 4-5 times more for their funding requirements due to this ban. “The cost of finance under LoUs is low: Libor plus 50 to 100 basis points. Due to the restriction on their issuance, the cost of funds will shoot up,” said Pankaj Mohindroo, President of the Indian Cellular Association, the industry body representing domestic phone brands such as Micromax and Intex.

The high cost of financing puts Indian brands at a disadvantage compared to their Chinese counterparts such as Xiaomi, Vivo and Oppo. “China is still supportive of its corporates. Chinese companies don’t have much LoU exposure and, therefore, have a competitive advantage now. Our competition is sitting comfortably while we are getting hit as we still await achhe din ,” said SN Rai, Chairman and Managing Director at Lava International. “The ban on LoUs is making our procurement tougher and is impacting our cash flow.”

The mobile phone industry is characterised by extreme competition. “The hyper competition impacts everyone, but the global players are still able to keep their head above water because of their financial capabilities, which makes global-benchmarked financial resources available to them,” Mohindroo said.

Mobile handset and component companies were able to enjoy credit using the LoU facility for one to six months so far. With LoUs, the industry used to get finance at London Interbank Offered Rate (Libor) at 2 per cent plus a spread of 50-100 bps so the rate of finance varied between 2.50 per cent and 3 per cent. Now, most domestic companies have to use their credit limits, which come to 10-12 per cent.

“The sudden move by the RBI is highly detrimental to trade. Bankers will tighten the trade finance process and insist on more collateral and other documents for bank guarantees and letters of credit, the only two finance routes available for importers,” said an industry expert.

Jobs at stake

The government’s ‘Make-in-India’ push had led to the establishment of more than 120 mobile-manufacturing plants in the country in the past 30 months, generating over 4.5 lakh jobs. With particular emphasis on export-led growth, the industry was expecting to achieve the target of producing 500 million units by 2019-20, generating 56 lakh jobs. The new restrictions have put these plans in jeopardy.

The Indian Cellular Association is approaching the Finance Ministry demanding that banks immediately sanction interchangeability of non-fund-based limit to fund-based limit to honour the LC payment and sanction short-term loans to honour LCs and buyers’ credit payment.

High financing cost could lead to higher handset prices, but the industry, for now, has decided to absorb the impact to stay competitive in the market.

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