GUARANTEES from foreign exchange perspective
Issuing guarantees by banks or other entities resident in India on behalf of and in favour of residents in India and denominated in INR does not attract any foreign exchange provisions. However, where one or more of these conditions is not satisfied, it attracts provisions of FEMA, which we shall examine here.
As per section 2(e) of FEMA, “Capital Account Transaction” means a transaction which alters the assets or liabilities, including contingent liabilities, outside India of persons resident in India or assets or liabilities in India of persons resident outside India. This provision relating to guarantees is further elaborated in section 6(3) as per which, following is a capital account transaction viz.: giving of a guarantee or surety in respect of any debt, obligation or other liability incurred
- by a person resident in India and owed to a person resident outside India; or
- by a person resident outside India
Thus, for broad understanding purpose, we can say that currency of the guarantee is immaterial from forex perspective but the possible [contingent] flow of foreign exchange across the border, on the invocation of the guarantee [if happens] is the criterion to decide the applicability of foreign exchange provisions. The guarantees given by banks [e.g. on behalf of customers] or guarantees given by companies [e.g. on behalf of or favouring subsidiaries outside India] are all covered under these guidelines. Such guarantees can be issued only to the extent and subject to conditions allowed under RBI permission, though one should hasten to note that many routinely required and trade supporting guarantees can be issued freely under delegated powers.
Foreign Exchange Management (Guarantees) Regulations, 2000 with its amendments, RBI Master Circular on Guarantees and Co-acceptances and RBI instructions contained in other related subjects provide guidance on this subject. Banks while issuing guarantees on behalf of customers, corporates while issuing their corporate guarantees for overseas transactions should ensure adherence to these. Knowing what is allowed and what is not, helps corporates and other forex consultants while discussing business.
Banks [i.e. which are authorised dealers] can issue following types of guarantees:
- Favouring a person resident outside India on behalf of exporter resident in India on account of exports from India. In particular, RBI has advised that
- Banks should be flexible in the matter of security and margin for issuing bid bonds and export performance guarantees and obtain ECGC cover, where needed.
- Banks should obtain an undertaking from the exporter that when the guarantee is invoked, the bank would be entitled to make the payment, notwithstanding any dispute between the exporter and the importer. Although such an undertaking may not prevent the exporter from approaching the Court for an injunction order, it might weigh with the Court in taking a view whether the injunction order should be issued.
- Banks should carry out due diligence and verify the track record of exporters to assess their ability to execute such export orders before issuing such guarantees.
- Export performance guarantees should be in the nature of performance guarantee and should not contain any clause which may in effect allow such performance guarantees to be utilized as financial guarantees/Standby Letters of Credits.
- Favouring a person resident outside India on behalf of an importer resident in India in respect of permitted imports on deferred payment.
- On behalf of a person resident outside India favouring a person resident in India in connection with a bonafide trade transaction [including acquiring shares of a company in India in certain circumstances] but only if it is covered by a counter-guarantee of a bank of international repute resident abroad. If this guarantee is invoked, there will not be any outflow of foreign exchange but a possible inflow of forex will have been prevented and hence this counter-guarantee requirement.
- Where guarantees of only resident banks are acceptable to overseas buyers, the bank can issue a counter-guarantee on behalf of Indian exporter to facilitate this.
- For stocking traveller’s cheques for sale at its branches or by other authorised person customers like money changers, organisations outside India which supply these insist for guarantees before supply. Banks can issue such guarantees.
- Guarantees in respect of missing or defective documents, or authenticity of signatures on behalf of its customer or branch or correspondent outside India, in the normal course of business.
- Guarantee to or on behalf of a JV or WOS set up outside India [as per FEMA] by a client company in connection with its business.
Other than banks e.g. companies can issue the following types of guarantees:
- An exporting company can issue a guarantee for the performance of an approved project outside India or for availing [fund-based or non-fund based] credit facilities from a bank or a financial institution outside India in connection with the execution of such project.
- Guarantee by the Indian parent company to or on behalf of a JV or WOS set up outside India [as per FEMA] in connection with its business.
- An agent in India of a shipping or airline company incorporated outside India can give a guarantee on behalf of such company in connection with its obligation or liability owed to any statutory or Government authority in India.
A company should not avail domestic rupee-denominated structured obligations by obtaining credit enhancement in the form of guarantee by international banks, international financial institutions or joint venture partners, except with RBI prior permission or to the extent of exemptions permitted for infrastructure companies.
It may be noted these specific guarantees allowed are not mere examples but are the only allowed guarantees. In other words, no person resident in India can give a guarantee or surety in respect of, or undertake a transaction, by whatever name called, which has the effect of guaranteeing, a debt, obligation or other liability owed by a person resident in India to, or incurred by, a person resident outside India except to the extent specifically permitted.
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