Financial regulators have ordered the banking sector to open and expand credit limits on letters of credit (LCs) for petrochemical companies importing naphtha. The preemptive measure comes as the won-dollar exchange rate fluctuates around 1,500 won per dollar and the fallout from the U.S.-Iran war is expected to sharply reduce petrochemical firms' revenue and profits.
According to financial industry sources on the 27th, the Financial Services Commission (FSC) held a meeting with officials from commercial banks on the 25th and issued the directive. "The FSC conveyed that any disruption to the supply of naphtha, the raw material for ethylene, would have a significant ripple effect across the national economy," an industry official said.
The FSC convened a separate meeting to address LC management for petrochemical firms because their financial conditions are deteriorating rapidly. With Middle Eastern naphtha supply disrupted by the Iran war, domestic petrochemical companies have been lowering plant utilization rates, causing production setbacks. LG Chem, the country's largest petrochemical company, shut down the naphtha cracking center (NCC) at its Yeosu No. 2 plant on the 23rd, and the possibility of cascading shutdowns at other firms has been raised.
Adding insult to injury, surging exchange rates are causing petrochemical firms' LC limits to shrink without any action on their part. An LC is a type of payment guarantee in which a bank pledges to pay a foreign exporter on behalf of a company importing raw materials and goods, based on the bank's credit. Companies typically open LCs within limits set with their banks, deducting from the limit on a per-shipment basis. Because LCs are a form of credit extension, rising exchange rates result in a reduction of the total available limit.
When LC limits shrink, companies have no choice but to reduce import volumes, further worsening the situation. "Opening an LC requires the same level of screening as a regular loan, including the company's creditworthiness and collateral," a commercial bank official said. "When exchange rates rise, companies have an incentive to reset their LC limits."
The government plans to continue supporting the petrochemical industry, which has taken a direct hit from Middle East risks, while proceeding with business restructuring as scheduled. The Korea Development Bank (KDB) on the 25th briefed creditor banks of Yeocheon NCC, Lotte Chemical, Hanwha Solutions, and DL Chemical on Yeocheon NCC's business restructuring plan, and will hold a vote on selecting companies for restructuring on the 27th. "We expect measures similar to the Lotte Chemical and HD Hyundai Chemical cases, including fresh funding and conversion to perpetual bonds," a creditor group official said.
