Diamond industry

Rough cut

Print edition : March 16, 2018

A worker with his tools to check the quality of polish at a diamond cutting and polishing workshop in Mumbai. Photo: Adeel Halim/Bloomberg

At the polishing department of a diamond-processing unit in Surat, Gujarat. Photo: AMIT DAVE/REUTERS

The Rs.80,000-crore diamond industry exposes banks to high risks, but it is also a sector that generates significant returns. The Nirav Modi scam is, however, expected to have a big impact on the industry.

Seemingly, all was going well for the diamond trade until Nirav Modi got busted. With close to 90 per cent of the world’s rough diamonds arriving in India for cutting and polishing, the country’s diamond industry has by and large been on an upward trajectory in recent years. In fact, Mumbai and Surat are not just known for these specialised skills but are among the largest hubs for trading in the precious stone. The Punjab National Bank (PNB)-Nirav Modi scam has unfortunately cast a shadow on this flourishing sector, with questions being raised about financial backing, exports and quality checks.

Frontline spoke to bankers and diamond merchants in the diamond belt to get their perspective on the explosive scam involving their trade. While several bankers say this industry does expose banks to risks, it is also a sector that generates significant returns. Unfortunately, bankers and traders say the fraud is expected to have an impact on the approximately Rs.80,000-crore diamond industry. Bankers believe that there will definitely be a reduction in exposure now, and credit will certainly be tightened in the short term. Perhaps stringent measures to monitor and evaluate inventory will be put in place in the long term. Diamond traders say the pullback on credit will, in all probability, have a ripple effect on the industry. However, both bankers and traders say that streamlining, transparency and corrective processes are the need of the hour for the diamond business, which although highly lucrative has a shady underbelly.

Bankers say the quality of collateral, which is the problem with the diamond industry, needs to be improved. In most cases, the collateral is not hard assets but the inventory, and that is what makes lending a high-risk venture.

According to the CARE rating agency, the share of the gems and jewellery sector in the total credit exposure of banks to industries has been in the range of 2.5 to 3 per cent. The report says that at the end of financial year 2017, banks’ exposure to the gems and jewellery sector was at Rs.73,800 crore. The diamond industry in India is largely to do with exports and cutting and polishing.

Bankers say that while the exposure is huge, the returns are good as the term periods are short (typically 90 days). Besides, diamonds are a huge foreign exchange earner. Therefore, if the company is legitimate, banks will give loans as they do in the case of any other industry.

A commercial banker says: “The issue here is that the diamond industry is a working capital intensive business with very little investment in hard assets. The nature of the industry is characterised by low value addition of cutting and polishing raw stones by using cheap semi-skilled labour. Thus, the major investment by most businesses in the sector is in inventory. The inventory is usually given as collateral, and that is risky.”

Banks often find themselves compelled to keep lending because they have very little collateral to begin with and know that stopping credit would mean risking the entire loan as a non-performing asset (NPA), says the banker. Either because of this pressure or because of the gains, some nationalised banks would loan 5 to 10 per cent of the turnover exposure to the sector. Lending to diamond businesses is risky as most of them are unlisted companies. Their business model, in the absence of a corporate structure, is questionable. Most often, lending is based on trust and old associations, he says.

Further, industry experts say this trade is unique in that the nature of the product cannot be valued accurately. Rather it is difficult to give a precise value to the stones unless each and every piece is verified carefully. Besides, the volumes are so high that both banks and traders would find it a chore to examine each stone and keep a check on the massive inventory. Traders (obviously only those circumventing the system) benefit from the loophole in the system as they can pass off low-quality stones as high-quality ones.

The Indian diamond industry is categorised in the midstream segment within the diamond chain, says the CARE report. “The midstream segment is highly sensitive to price volatility and the demand-supply balance of rough and polished diamonds as they can only exert limited pressure over both ends i.e., suppliers and retailers. India constitutes the major share in the midstream segment primarily on account of its cost leadership and relatively more developed diamond industry financing infrastructure, with various forms of export and import credit available.” Midstream players earn the lowest operating margins in the value chain. If the market becomes sluggish, banks’ exposure increases, but the lending does not stop as the market has to be kept alive.

Line of credit

Diamond companies are given credit in the same way that any company is given a loan. A line of credit is drawn against a specific consignment. The letter of undertaking (LoU) is given by the issuing bank to the receiving bank to pay a certain amount of money on a specific date. Interest rates are established depending on a number of factors, which include prime lending rates or the industry benchmark. The problem occurs when loans are rolled over. If a borrower cannot repay, he takes another loan to repay the first one and the accumulated interest, and the sum keeps growing. Essentially, that is what Nirav Modi did for seven years.

Dhanjibhai Mavani, secretary, Surat Diamond Association, says loans may range from Rs.2 lakh to several crores depending on the size of the unit. Additionally, the requirement would depend on the rough diamond price, the availability and demand. But whatever the reason, there is always financial requirement, particularly since the diamond industry has been stable since 2016. “The big companies have ‘settings’ with the banks. They always get their money. It is the small businesses, which are in their thousands in Surat and Mumbai, that will now find it difficult to get access to finance,” says Mavani.

“The diamond industry and the banks have been best friends for decades,” says Harsh Jhaveri, a Mumbai-based diamond exporter. “Banks have always financed and will continue to lend to the diamond industry. It is a high-volume, short-term gain situation, which fetches them a lot of money. Banks are not doing any favours, but they need to be aware that it is taxpayers’ money that they are toying around with. But this case does expose the fact that powerful people have access to funds and the industry’s low credibility tends to expose the banks to high risk.” Nirav Modi, Mehul Choksi and the other jewellers, who are now on the run, allegedly exploited this relationship with the banks to get capital from Indian banks abroad against LoUs given in India. Industry insiders say this is a common practice and is done the world over as interest rates are lower abroad. However, in Nirav Modi’s case, the loan amount was staggering and no one knows where the money has gone, says Jhaveri.

“Ever since 2016 when Modi became more public as he entered into manufacturing and retail, we knew something was not right. Such a meteoric rise in a short time should have raised a red flag. There was plenty of talk on him and Choksi as they were borrowing within the community as well. They have strong brands, are very powerful and have deep connections. Therefore, people were apparently lending readily. We do know that Modi paid back what he borrowed [from the community], so he ensured that the community was not hurt,” says Jhaveri.

Interestingly, a few days after the scam hit the headlines, an email circulating among diamond traders, reportedly written by a group of businessmen at the diamond bourse in Mumbai, shows their support to the tainted businessman. It says: “In the last seven years. NM paid each and every LoU on the due date. Each LoU comes due in 90 days. He paid all of them in last seven years including the last one due in January, was also paid. Hence, there is no default from his side at all. The only fault is that NM has taken an LoU, which is like a bank guarantee, without giving collateral. But this is *not cheating of money* - this is simply a *risk* that PNB has taken. In the first year, it was a small risk and in the later years as his business grew it became bigger. But he always paid in 90 days.”

Jatin Mehta case

Traders in Surat are not as supportive. In fact, they say demonetisation and Goods and Services Tax have had little impact on the industry. This scam, however, will be detrimental to business. “It is always these big people who default, and the effect is felt by us,” says Babubhai Gujarati, who owns five polishing units in Surat. “Even Jatin Mehta has not been caught [referring to the Winsome Diamond scam]. There is certainly an underlying sentiment that the bigger the fish the harder to catch.”

The Winsome Diamond Group case is not just about the owner, Jatin Mehta, remaining free; it is also an example of how vulnerable banks are when lending to the diamond industry. After taking loans amounting to a staggering Rs.6,800 crore, in 2013, the merchant began defaulting on loans and was eventually termed a wilful defaulter. Although the case is with the Central Bureau of Investigation, banks in India are unable to recover any money from Winsome. The company filed a case in the United Arab Emirates (UAE) claiming that it had suffered a $1 billion loss owing to non-payment by UAE firms and, therefore, did not have the capacity to repay the loans. It won the case. The UAE has refused to help the Indian authorities take the investigation forward.

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