The Reserve Bank of Zimbabwe (RBZ) is desperately seeking renewal of letters of credit (LCs) from offshore financiers as part of a financial bailout package for Zimbabwe companies reeling under a crippling shortage of foreign currency, Business Times has learnt.
RBZ governor John Mangudya said the restoration of LCs was aimed at the “mere survival” of industries such as the fuel, cooking oil, grain, and the pharmaceutical sectors.
Mangudya, however, did not provide the value of the requested LCs.
Following crippling shortages of foreign currency, the debt instruments have increasingly been used to facilitate the completion of commercial agreements between local companies and offshore suppliers.
Local companies use LCs to assure international vendors that they have money to pay for the imported goods.
“Letters of Credit are still there and are still in operation. We have asked foreign banks to renew those,” Mangudya said.
But, he said the LCs will be scrapped when the interbank market is fully operational.
Zimbabwe’s interbank market has not been efficient since the government liberalised the foreign exchange market as well as reducing its involvement over the interbank market’s control in February last year.
This week, the official rate on the interbank market stood at ZWL$24: US$1 against the black market rate of as much as ZWL$44 to buy US$1.
Foreign currency, however, has not been available on the official market. Finance Minister Mthuli Ncube for the first time two weeks ago admitted the interbank market was being abused by some banks.
This week, some banks, however, were said to be selling foreign currency at more than ZWL$40 for US$1, which was clearly an abuse of the system.
Now, the Treasury boss and the monetary chief, Mangudya, are revamping of the interbank system.
Until this happens, the central bank will continue issuing out LCs.
Under the arrangement, the RBZ avails LCs into the market to ensure the availability of critical imports such as the importation of fuel, cooking oil and pharmaceutical products.
In view of prevailing foreign currency shortages, the majority of companies currently dependent on LC for critical imports such as imports and equipment, which are required to keep production going.
And the burden will be left to RBZ which will allocate foreign currency through LCs to local companies for the settlement of foreign obligations such as the importation of raw materials critical for industrial production.
They use them to access critical raw materials.
The central bank undertakes to pay in future date through issuing these financial or commercial instruments to ensure long-term availability of critical imports.
In essence, an LC is a promise made by its issuer, being a financial institution, but guaranteed by the RBZ in the case of Zimbabwe, that they will pay in the future.
Importing companies are then allowed to pay in Zimbabwe dollars on the transactional account, which is local currency, and then the RBZ will then pay later for the imported goods that would have been delivered and consumed.
Usually, LCs are payment terms mostly used for longdistance and international commercial transactions.
Using LCs allows the seller to significantly reduce the risk of non-payment for delivered goods, by replacing the risk of the buyer with that of the banks.
They have become a crucial aspect of international trade and make it possible to do business worldwide.
Originally, LCs are written by the buyers’ bank to the sellers’ bank promising that they guarantee to pay the seller in case the buyer’s default.
But, in the modern business world, an LC is basically an undertaking by a bank to make payment to a named beneficiary within a specified time, against a presentation of documents which is strictly in compliance with the terms of the letter of credit.
That is to say, banks issue letters of credit as a way to ensure sellers that they will get paid as long as they do what they have agreed to do that is to supply.
The RBZ issues and guarantee that the supplier will be paid with the local banks processing the LCs.