The Reserve Bank of India seal appears on a gate outside the RBI headquarters in Mumbai. Photo: Reuters

Exporters in India are upset with the central bank’s decision to suspend letters of undertaking (LoUs), instruments that were misused by diamond merchant Nirav Modi and his associates to take out loans worth 130 billion rupees (US$2 billion) from Punjab National Bank.

Some of them said the move by the Reserve Bank of India (RBI) could not be treated as a solution for cleaning up the trade finance system and would hit the large exporting companies hard, reports Business Standard.

LoUs are used heavily by exporters, across sectors such as gems and jewelry, heavy engineering and some others, that import goods that go into the making of export products. As a result, export from these sectors is expected to decline, even as the cost of funding would rise for companies.

However, the RBI said other instruments such as letters of credit and bank guarantees, the international norm, would continue to be provided by banks.

Letters of credit are safer instruments, but are much more expensive than LoUs. In letters of credit the receiving bank also conducts its own credit appraisal on companies before accepting them, which reduces the risk of defaults.