The recent proposals made by the Gem and Jewellery Export Promotion Council (GJEPC) for the 2013-2014 Union Budget are a step in the right direction but are not far-reaching enough. One hopes the government will give the recommendations sufficient consideration as it makes its final adjustments ahead of finance minister P. Chidambaram’s budget speech on February 28.
The most significant of the proposals is reducing the rate at which business income tax is calculated from 6 percent of turnover to 2.5 percent and introducing a duty-free quota for polished diamond imports amounting to 15 percent of a company’s previous year exports.
[two_third]It wasn’t so long ago that the GJEPC was lobbying for last year’s introduction of a 2 percent import duty on polished diamonds. The council’s motivation was to curb round-tripping, whereby businesses took advantage of the free duty by exporting and immediately reimporting the same goods to artificially inflate their export volume and thus qualify for additional bank financing.
The import duty had more than its desired effect. Coupled with weak foreign demand, the duty influenced a dramatic reduction in India’s polished diamond trade in 2012. The country’s polished exports fell 37 percent to $16.99 billion during the year, while polished imports slumped 72 percent to $5.59 billion. This column’s assertion that round-tripping needed to be tackled by implementing tighter bank lending practices rather than via restrictive tax policy remains as true today as it was argued a year ago. [/two_third]
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“The country’s polished exports fell 37 percent to $16.99 billion during the year, while polished imports slumped 72 percent to $5.59 billion.”
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Still, the GJEPC has noted that India’s lower foreign trade is currently more reflective of the reality as a result of the duty. But it has also taken its toll, discouraging foreign traders from doing business in India and diminishing the country’s competitive edge. It’s likely that a significant volume of polished diamonds that would otherwise have passed through India are now being routed through Dubai, Hong Kong or other attractive trading centers which do not charge such hefty duty. Throughout the past year, the market has been awash with reports of Indian nationals from large diamond companies relocating elsewhere to facilitate such trade.
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The proposed duty-free window of 15 percent of the previous year’s exports may help India recapture some of that lost business. However, whether by design or default, the GJEPC proposal falls short of encouraging foreign companies in the polished sector to operate in Mumbai. For India’s diamond industry to grow and avoid becoming just a manufacturing hub a strong foreign presence in Mumbai is still required. Despite the local industry’s vast numbers, India cannot sustain a vibrant trading hub on its own. More foreign companies should be opening offices in the Bharat Diamond Bourse, but, barring Rapaport – which opened its new India headquarters there this week – and a select few others, they are not.
To its credit, while the GJEPC is focused on raising India’s polished trade numbers, encouragingly, it seems to be making progress in lobbying the government. This week’s announcement that India has re-introduced a provision for setting up private or public bonded warehouses for the gem and jewelry sector is an accomplishment of no small measure.
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“For India’s diamond industry to grow and avoid becoming just a manufacturing hub a strong foreign presence in Mumbai is still required.”
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As a result, companies can avert paying the respective duty on polished diamonds, colored gemstones, uncut and unset precious and semi-precious stones by importing the goods to a designated special economic zone (SEZ) or public bonded warehouse and re-exporting them, provided they add at least 5 percent value to the goods during the holding period. Again, the move will encourage further diamond and jewelry manufacturing in India, but not trading.
Similarly, the council’s recommendation to establish special notified zones for the import and trade of rough diamonds is aimed at enhancing its rough supply to the manufacturing sector. It is seeking to attract the likes of Rio Tinto, ALROSA, and other miners as well as some large dealers who would compete to sell rough in the country. Having increased its rough imports by volume by 3.7 percent in 2012, the GJEPC notes that an increase in manufacturing leads to increased employment and a rise in diamond jewelry exports, which ultimately has a positive impact on India’s balance of payments.
That may be so, but there remains a concern that the country’s manufacturing needs, which are arguably already sated, are overshadowing its long term interest to have international diamond traders come to Mumbai to buy and sell polished diamonds.
The government’s perspective is different and understandable. Faced with one of the widest budget deficits among the world’s large emerging economies, the country is unlikely to meet its initial deficit target of 5.1 percent of gross domestic product (GDP) for 2012-13. Fitch Ratings this week warned of a possible downgrade if the country does not meet its revised fiscal goals.
Equally worrying, the country’s current account deficit hit a record high of 5.4 percent in the second quarter that ended September 30, 2012, and the combined effect of the two deficits likely contributed to the significant weakening of the rupee in 2012. Adding salt to the wound, the government on Thursday lowered its growth forecast to 5 percent for the fiscal year that ends on March 31, 2013, below analyst expectations.
The government has responded with an attempt to curb imports, targeting its intake of precious metals. Last year, along with the 2 percent import duty on polished diamonds, the government implemented a 6 percent duty on silver and 4 percent on gold – which it raised to 6 percent just a few weeks ago – surprisingly, ahead of the budget speech.
While these actions may be required to reduce the current account deficit, they are hurting the local jewelry trade and diminishing India’s historic penchant for all things shiny. India’s gold jewelry consumption fell 16 percent year on year to $27.42 billion in the 12 months up to September 30, 2012, according to the World Gold Council’s latest Gold Demand Trends report. The increased duty is expected to further reduce jewelry consumption as gold products will likely become more expensive to retail.
The GJEPC is therefore in a sensitive position given the country’s fiscal requirements and understandably needs to choose its battles. The council’s budget recommendations were cautious and will hopefully prove effective come February 28. But it needs to take the next step thereafter, which would require more of an open-door policy to allow foreign entities a space in the market. For beyond the trade numbers, the local industry needs to grow. And it cannot do so in an insular, non-competitive environment.
