Rupee Insecurities

Avi Krawitz

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. ‎

Source Rapaport