The signing of a phase-one US-China trade agreement in January started the year off on a positive note for India, given that an estimated 35% to 40% of its polished-diamond and jewelry exports go to mainland China and Hong Kong.
Then came news of the COVID-19 outbreak later that month. The resulting disruption was only the latest in a series of developments and regulations that have made doing business increasingly difficult for the Indian diamond and jewelry sector in the last several years.
As the largest exporter of cut and polished diamonds in the world, India has been a key factor in the tectonic shifts the industry has faced recently. The country imports approximately 90% of the world’s rough diamonds, and had polished export figures of about $24 billion in 2018, according to the Gem and Jewelry Export Promotion Council (GJEPC). The entire gem and jewelry sector, at $40 billion, currently accounts for approximately 12% of India’s total exports and is therefore vital to maintaining the trade balance.
Here are some of the challenges that national and global events have presented for the country.
Coronavirus and credit
In 2019, the global economy grew by only 2.9%, according to the International Monetary Fund (IMF). US financial website MarketWatch called this “the slowest pace since the 2008-09 global financial crisis and just 0.4 percentage points above the 2.5% threshold typically associated with a worldwide recession.” And if growth was slow before, the coronavirus has now effectively brought people and businesses to a standstill.
While the negative impact on jewelry sales may have started in China, the ripple effect is now being felt globally. Indeed, one of the major differences between the COVID-19 situation and the SARS outbreak of 2003 is that today’s global businesses are far more dependent on the approximately
$14 trillion Chinese economy as both a producer and a buyer.
What does this mean for India? One of the issues is an inability to pay back loans. Midstream players in India effectively operate on a 90- to 300-day cash cycle, according to industry sources. Manufacturers take loans from banks to purchase rough diamonds from mining companies, then offer cut and polished goods on consignment and take out additional “receivable loans” to cover expenses until they receive payment for those goods. Due to the virus, though, fresh export orders have dried up, and outstanding payments from clients are mounting.
Meanwhile, Moody’s has revised its outlook on the Indian polished-diamond industry to negative. Despite stable rough-diamond prices, there was a sharp drop in polished pricing during the first half of fiscal 2020, which caused a decline of 1% to 3% in polished-diamond players’ EBITDA margins, the financial-services company said in a February report. The latest developments, as per Moody’s, indicate that manufacturers will have a tough time generating enough sales to cover their fixed overhead costs for the rest of the fiscal year.
The road to reforms
In the past, banks were eager to provide generous lending terms to large-scale diamond manufacturers, and this availability of cheap credit became an incentive for people to enter the diamond business — even if their interests lay elsewhere. As such, some of these parties had alternate aims. Since there was no import duty on rough diamonds at the time, certain manufacturers would over-invoice their goods to get higher credit facilities from the banks for pre-shipment purposes such as purchase and processing. In 2018, money laundering investigations found several entities allegedly importing rough diamonds at hugely inflated rates, according to an Economic Times report. These entities would then funnel the extra funds they got from the banks into real estate investments and other ventures. Not surprisingly, the government countered this phenomenon with reform.
To appreciate the impact of India’s regulatory reforms, one must first understand its recent economic history. In 2013, only 1% of the population — 12.5 million people — paid direct taxes, according to a report by India’s revenue service. The challenge India faced at that time
was to find a way to dismantle the parallel economy, which functioned in off-the-grid cash transactions — especially in the luxury, real estate, gem and gold-jewelry sectors.
In November 2016, the Indian government made the bold move of rendering INR 500 and INR 1,000 currency notes illegal tender, virtually overnight. Those notes accounted for 86% of total currency value in circulation at that time — approximately $320 billion — according to media reports. On the day of the announcement, reports claim, 15 tonnes’ worth of gold was purchased in cash in less than four hours. The resulting chaos brought the economy to a grinding halt, impacting consumption, asset purchases, real estate and other areas.
In the aftermath of this demonetization policy, as midstream players in the Indian diamond sector struggled to comprehend their substantially revised liquidity positions, global producers offloaded 26 million carats of rough diamonds into the pipeline in 2017 — the largest single-year increase in production since 1986, according to a report by Bain & Company and the Antwerp World Diamond Centre (AWDC). India’s regulatory reforms continued with the introduction of the goods and services tax (GST) in July 2017, further adding to diamond manufacturers’ administrative woes.
To make matters even worse, in January 2018, news emerged of the alleged $2 billion fraud by Nirav Modi and certain officials at a large, nationalized bank in India. This brought the issue of “round-tripping” into the spotlight, as Modi and jewelry retailer Gitanjali Gems had allegedly been exporting diamonds through international ports, acquiring export loans in each country for essentially the same lot of goods, and re-importing them back to India. This not only enabled them to get multiple loans per product, but also gave the appearance of numerous transactions and therefore a successful business.
Turning up the taxes
Soon after, the Indian finance ministry increased the import duty on cut and polished diamonds from 2.5% to 5%, and then again to the current 7.5%. While this addressed the problem of round-tripping, it created a new one. Industry sources estimate that some 20% of diamond processing units depend on “closeout diamonds,” also known as recycled or broken diamonds — stones acquired through estate sales in the US and exported to India for recutting. To counter rising rough prices, factories would sometimes use closeout diamonds as an alternative raw material to keep the processing wheels turning. Since many manufacturing units are located outside special economic zones — areas where import taxes do not apply — the 7.5% duty on polished diamonds has caused disruption in this segment.
An easy fix for the finance ministry would be to categorize closeout diamonds as a raw material, since rough diamonds and gemstones carry only
a 0.5% duty.
However, that duty itself is a recent development that has rattled stakeholders; previously, there was no import tax on rough. Media reports suggest the new tax’s objective is for authorities to observe and learn from the changes in (declared) import values of rough gemstones and diamonds. But the industry fears it will result in further disruption, including job losses (the sector employs 4.64 million people, according to the GJEPC) and increased harassment at ports. Traders also worry it will make polished goods from India less competitive on the international market.
“Our inability to provide after-sale services...to international clients [such as repairing or resizing jewelry, which would require Indian companies to re-import the pieces when customers send them in from overseas], is negatively impacting the capability of Indian jewelers to develop their business at a global level,” notes Milan Chokshi, the GJEPC’s convenor for marketing and promotions.
Working on solutions
These regulations over the last three years have been part of the Indian government’s efforts to formalize the economy. By increasing the number of people who open bank accounts and make digital payments, the government aims to bring the parallel economy onto the grid.
And while these moves have made business difficult for the gem and jewelry trade, the government has also been working with the GJEPC to find solutions.
“Our top three priorities right now are [first of all] to work with the government and bankers to ensure our exporters don’t get affected on credit against receivables; secondly, we will have to make greater efforts to develop new markets [beyond China and Hong Kong]; and thirdly, we hope to get policy respite on duties and taxation to ensure maximum manufacturing shifts to India,” says GJEPC vice chairman Colin Shah.
On the first point, the trade body is asking the government and the Reserve Bank of India (RBI) to extend the credit period by another six months so manufacturers have more time to secure pending payments from China and Hong Kong.
“The Indian government — especially the commerce ministry — has been a massive supporter of the industry,” Chokshi stresses.
Regarding the taxation issues, Chokshi says the industry is asking the government to reduce import duties and amend the tax laws to make it easier for foreign mining companies to sell rough diamonds in the Special Notified Zones (SNZ) of Mumbai and Surat — a similar system to what hubs like Belgium have in place. The industry has also proposed a tax refund scheme for foreign tourists in an effort to promote domestic gem and jewelry transactions, he says.
Not so simple
While state initiatives such as “Make in India” — which aims to encourage companies to manufacture their products in the country — and e-commerce projects have been a priority, there are difficulties on both fronts.
“Under India’s import-export policy, an entity is allowed to export diamonds to international gem labs for accreditation — like American Gemological Laboratories (AGL), the Swiss Foundation for the Research of Gemstones (SSEF), Gübelin, or the Gemological Institute of America (GIA) — but the same benefit is not permissible for gemstones [such as] emeralds, rubies and sapphires,” explains Atul Jain, director of prominent jewelry retailer Almas Jewels. “How can Indian companies compete internationally when they are unable to provide comprehensive reports from internationally recognized labs?”
Another challenge Jain cites is “access to quality tools and machinery. The current law only provides an exemption of import duty to large-scale exporters of jewelry or those operating from special economic zones, while manufacturers catering to the domestic market — usually working at a small-medium scale — find the cost of importing quality equipment prohibitive due to high taxes. [Small and medium-sized enterprises] are stuck using traditional techniques, which in today’s progressive climate can’t deliver internationally accepted quality, which even Indian consumers now desire and expect.”
Amid the storm of uncertainty, all eyes are on the GJEPC, the finance ministry and the RBI. Can the GJEPC get the additional six-month credit extension from the bank? Will the finance ministry adjust import duties in the months ahead? For now, all stakeholders can do is watch and wait, and hope that once the dust settles, jewelry consumption will return with a vengeance as it did
post-SARS, and the pent-up demand will bring a certain degree of recovery.
Image: ShutterstockArticle from the Rapaport Magazine - April 2020. To subscribe click here.