The decision by the Indian government to force its citizens to convert half their foreign currency to rupee was another of a growing list of directives negatively impacting the diamond industry. The result is that 2012 is set to become an even more challenging year than expected for the trade.
In January, the introduction of a 2 percent import duty on polished diamonds was designed to strengthen local manufacturers against rising foreign dealer competition, but had the effect of diminishing Mumbai’s importance as a trading hub (see editorial entitled “Protecting India” published on March 2, 2012). Similarly, the latest move to strengthen the currency will ultimately curb the local industry’s competitive edge.
The rupee has had a turbulent time over the past 12 months and this week hit a record low of INR 54.6 to $1, despite the government’s attempts to boost its value. That’s a 20 percent decline from one year ago. Since the beginning of 2012, the currency has trended along an almost perfect “V” curve, starting in January at around INR 54 and appreciating to INR 48.6 in February before slipping back to this week’s rate. As a result, India’s cost of living has increased and consumer confidence has subsequently declined. Volatility on the Bombay Stock Exchange reflects investor jitters.
In an attempt to stop the free fall, the Reserve Bank of India is seeking to boost rupee holdings. The bank has given holders of foreign currency two weeks beginning May 10 to convert 50 percent of their foreign exchange to the local currency.
The Associated Chambers of Commerce and Industry of India (ASSOCHAM) suggested that bolstering internal demand will help strengthen the currency, especially since global export demand is waning. This is true and has proven effective in the past when local demand helped bolster India’s position in the market, compensating for weak demand elsewhere during the 2008 crisis.
By raising the amount of rupees in the market, the bank is seeking to enhance local consumption. That in itself is positive. But there are other ways to do this that would not be to the detriment of export-reliant industries like the diamond trade. ASSOCHAM proposed increasing dollar inflows and raising remittances from non-resident Indians (NRI) to alleviate pressure on the rupee. “NRI deposits in the country can be raised by at least $10 billion to $15 billion in the short term by taking confidence-building measures and offering attractive interest rates,” ASSOCHAM said.
A weaker rupee should help exporters. But overall sentiment is weak and there are concerns that foreign investors will exit India to ensure global risk aversion and due to domestic challenges. The new exchange controls will bring additional challenges to export industries.
India’s foreign diamond trade has already slumped in 2012, largely due to the new import duty. Polished exports fell 42 percent year on year during the first quarter and polished imports declined by 71 percent. Fewer foreign buyers are shipping goods to India, and with high rough prices and resulting slim profit margins, liquidity is tight.
Until now, the local diamond manufacturing and trading sector has been largely protected from the weak rupee given that it is predominantly an export market. In fact, the larger exporters have possibly gained from the stronger dollar since it has raised the value of their inventory in dollar terms. Rather, it was more the small- to- medium-sized operations that found it difficult to compete as they were being squeezed by the rupee exchange. Some of those rely on the domestic market and sell in rupee, while others do not have dollar accounts and were forced to convert to the local currency.
However, that will now change as exporters are required to liquidate their foreign exchange. Diamond exporters stand to lose on the transaction. They will need to reconvert to dollars when they are ready to purchase rough or polished goods. For local diamond manufacturers, rough prices therefore will become even more expensive.
The result is that the Indian government is preventing its diamond trade from operating efficiently. More importantly, operating in a dollar-based industry means liquidity will tighten even further.
Nobody likes to be told what to do with their money and one should expect Indian exporters to do what they can to protect their interests during this current fortnight. There may be a flight of capital from the country as they seek creative ways to ensure access to their much needed dollar-based funds.
In the same way that this column argued when the government introduced the 2 percent import duty on polished diamonds, these new exchange controls will serve to strengthen other diamond centers. Simply put, the controls increase the cost of doing business in India and discourage diamond trading from taking place in Mumbai. Indeed, centers such as Hong Kong, Dubai, New York, Antwerp and Ramat Gan may well be the ultimate beneficiaries.
The controls, and the import duty that preceded them, signal that India is moving in the opposite direction to the rest of the world when it comes to encouraging industry growth. Rather than restricting the trade, it should seek out ways to ensure that India maintains its position as the world’s most important diamond manufacturing and trading center.
As large as it is, India is not too big to fail. But for now, it is big enough to impact the rest of the market. The more government influences the way the trade operates, the less inclined others are going to be to deal with it. But for India’s own sake, the government needs to facilitate the local diamond trade to increase its competitive edge, not diminish it. By doing the opposite, the government is ensuring challenging times for the industry for the rest of 2012, and beyond.