The Indian diamond industry has been in the grip of an unprecedented liquidity crisis, the likes of which not seen for the last 50 years.
Genuine, oh heck, no. It’s actually self-made as reportedly big and medium diamond firms have diverted $5.4 billion (Rs 30,000 crore) in bank finance meant for diamond operations into real estate. With the slump in real estate, these firms are now caught in an unprecedented fund crunch. How do you repay it?
A bad situation threatens to become worse when it comes at the back of a sharp decline in imports of rough cut diamonds and consequent fall in export of cut and polished diamond – it has the potential to literally break the back of the industry.
So much so that the diamond industry has pushed the Union Commerce Ministry to come out with a status report by a Directorate General of Foreign Trady (DGFT) task force to address issues affecting it.
Diamond exports are set to fall by $7 billion in 2012-13 from $25 billion achieved in 2011-12.
The task force took serious note of India’s shrinking share in the US market, China’s growing dominance in global markets and its direct diamonds for commodities barter deals with Africa and suggested remedial measures like establishment of a special fund by the Reserve Bank of India, $3 to 5 billion for refinance of borrowings given to non-petroleum products which have high import content of 70 per cent.
The diamond industry comes under this category and is eligible for this facility. If such a financing facility cannot be made available then they should be allowed ECB (external commercial borrowing) facility in foreign currency to finance the import of raw materials.
While all this sounds good, the cause for worry is whether the government has erred in its judgement and glossed over a more serious issue which is the real cause of the crisis in the diamond industry– bank deals here do not seem right at all.
So a crucial question is thrown up: if government sets up a fund to bail out the diamond industry, then is the money going to bail out the industry or is it just going to cover the losses of some speculators in the industry who have diverted genuine bank finance into real estate and with the recession in the reality industry, are stuck with a no go situation in terms of returning bank funds.
The funds problem is further compounded as a major part of this borrowing was based on ‘round-tripping’ – the repeated export and import of the same parcel of diamonds to boost turnover and export figures to get low interest finance from banks. Some diamond firms reportedly used such finance from several high-street lenders to dress up their book losses.
Money is being pumped out from the diamond pipeline creating problems for the rest of the players, if the statement of former Gem and Jewellery Export Promotion Council (GJEPC) vice-chairman, Sanjay Kothari is to be believed. India’s diamond export figures, he says, are “false and manipulative.’’
The export of $28 billion worth of polished diamonds and the import of $20 billion worth of polished diamonds in 2010-11 was the classic example of round-tripping. India is a diamond exporter and there is no need for importing polished diamonds.
The government introduced a 2 percent subvention scheme by which import of polished diamonds attracted a duty. When it was first introduced, it led to a marked decline not in exports but in export value – falling from as high as $ 20 billion to $ 5.8 billion. Actual exports had not declined but the inflated value of exports had come down.
So there is a clear link between round tripping and bank financing. The real dimension to this problem is that the surplus money that came in to the industry in the diamond pipeline did not actually go for betterment of diamond trade but into speculative land deals in the realty sector and speculative buying of rough diamonds from unofficial sources. Both of them have plunged the diamond industry into a financial crunch with one additional handicap -a suspect image.
How did the practise of round tripping start? It all started as an unexpected offshoot of the diamond industry’s request to the government to change the way it was taxed. Instead of being taxed on profit, like most other industries, it sought to be taxed on turnover, like the diamond trade in Israel. So in May 2007, the government scrapped the three present duties on polished imports. Round-tripping became an economical practice since then, a completely new way to make money from diamonds.
The government certainly does not want a major financial crisis. The genuine small to mid-sized diamond merchants, not involved in round-tripping, actually find it difficult to access bank credit they want for their business to be conducted in an open economic environment.
Viewed in this background, the task force should have come out more harshly against this practise and suggested measures to curb it altogether instead of taking an easy way out suggesting additional funding.