Mandatory LC margin -- a positive move

The latest move by the central bank to impose mandatory LC (letter of credit) margin in order to discourage non-essential imports appears to be well taken. The central bank issued a circular in this connection with a view to containing the massive growth of imports amid erosion of the country's foreign exchange reserve. No doubt a timely initiative to constrict forex spending reflects central bank's wisdom to be cautious about any untoward eventuality that might offset the economy in this uncertain time. According to a report published in the FE, depositing minimum 25 per cent cash margin on LC for imports, except some essential items, is now mandatory under the central bank's monetary measure to ease pressure on import payments. The products exempted from the LC margin restriction are baby food, essential food items including lifesaving drugs, inputs for local and export-oriented industries and agriculture-related imports.

While there may be views opposing the move fearing it might tighten forex spending, common knowledge suggests that as a primary step this will have a positive impact on import payments by way of curbing nonessential imports. After all, payment of no less than 25 per cent LC margin in advance is likely to be a strong and desirable deterrent to nonessential imports. However, the question that may bother the authorities is the classification of essential and nonessential products.       

 It is generally assumed that import liberalisation facilities such as not suggesting LC margin, among others, are behind the mounting trade deficit and current account deficit in recent times. The FE report mentioned above has stated that during July-Feb '22 fiscal, little over 52 per cent LCs were settled out of US52.60 billion worth of LCs opened. Trade deficit and current account deficit in the period reached US22.30 billion and US 12.83 billion respectably. In July-February of FY22, the country's import soared to $54.38 billion from $37.07 billion in the same period of FY21. The Asian Development Bank in its latest Asian Development Outlook (ADO) 2022 projected that the country's current account deficit would increase significantly in FY22. It is in this context that holding the rein of unbridled imports has been felt necessary, according to the central bank. It may be noted that the central bank was too liberal in not imposing any LC margin in the past two decades or so. Way back in December 2003, the central bank asked all scheduled banks to determine the rate of LC margins for all kinds of imports on the basis of banker-customer relationship. The latest regulatory move comes in the backdrop of the rising trend in current account deficit alongside depreciation of local currency against the US dollar in recent months mainly due to higher import payment obligations.

Concerned quarters including noted economists have appreciated the move which they believe will considerably reduce pressure on import payments. However, there is the need to closely monitor the situation. Also, it is felt that in course of time the central bank might find a few more essential items to be brought under the exemption list.