From Slump to Sparkle – Finance is the Saviour

The global downturn is showing signs of taking a slow U-turn, moving the diamond industry up from its worst economic slump, in the longest and most widespread recession since World War II.

While the global recession, hardly less than a war for a bravely battling diamond industry, has claimed many businesses, it has also made industry leaders worldwide, dwell inward on some exposed flaws in their business dealings.

Diamond associations, banks and governments globally, have rushed to the aid of this ailing industry with credit restructuring packages, fresh finance infusions, official guarantees etc. for bailing out the millions of people dependent on this luxury industry.

Marathon Rescue :

All these marathon efforts are having an impact. In fact, in an official survey, a panel of 45 top economists in US, the major diamond market, have predicted an end to the country’s deep recession by late 2009, when economic growth is expected to turn positive. Although signs of stability are in place, the speed of recovery is expected to be slower than after past downturns.

Confidence Restored :

A similar sentiment is echoed in major diamond centres of the world, from Africa, Australia, Asia and Canada, where diamonds are mined to Antwerp, Tel Aviv and India, where diamonds are cut, polished and traded. This indicates that the diamond industry is breathing easier. Profits may be down, but confidence is on the brink of recovery.

Looking ahead, diamantaires and the banks that finance them, believe that the recession has exposed some structural weaknesses in the industry. The most crucial outcome of the credit crisis will be the inevitable correction that has to brought into the financing patterns prevalent in the diamond industry. Internationally.

Banks Become Tight Fisted :

With the downturn of the US economy, that absorbs more than 60 per cent of all diamonds in the world, the industry received a severe blow. Most people did not have money to buy diamonds. Markets collapsed. Diamond manufacturers were left holding stocks that were worth less than the finance taken to procure the roughs. Banks were left high and dry, worried about their payments due from an industry facing a sudden loss of export orders.

Says UDi Sheintal, managing director, Israel Diamond Manufacturers Association (IsDMA), “Around October 2008, when customers in the US and Asia stopped buying diamonds at the retail level, demand collapsed.”

Agreeing, Mahendra Shah of Mumbai-based C. Mahendra Exports said, “The sub prime crisis of USA adversely affected the global market and resulted in delayed payments. Moreover, the firmness of the US dollar affected other currencies and led to foreign exchange losses. The delayed realisations resulted in an additional interest burden, impacting the liquidity position of the exporters.”

With export orders being cancelled and cash flows drying up, the capital intensive diamond business defaulted on payments. Banks everywhere, in Israel and in India, took some stern measures as the liquidity crunch snowballed into an explosive crisis. To protect themselves, banks tightened credit facilities, raised interest rates and re-evaluated the credit worthiness of the industry.

Admits Sarat Mishra, General Manager (RM) of State Bank of India, Diamond Branch, Mumbai, “These are difficult times for the diamond industry across the world. There are no buyers. The industry is facing a severe liquidity crunch and our payments too have become overdue. In such a market, we cannot divert dollars for diamonds.”

Even in Antwerp, the situation is somewhat similar. Kaushik Mehta, Chairman, Eurostar Diamond Traders, an international company headquartered in Antwerp observed, “Slowdown in consumer spending, exposed the over-capacity of the polished diamond pipeline. While credit agencies downgraded certain diamantaires, stringent risk management actions were undertaken by various specialised banks servicing the diamond industry.”

Meanwhile, credit rating agencies in India too downgraded the diamond industry. In February 2009, ICRA issued a statement that “diamond processing is a capital intensive business and therefore heavily dependent on bank financing. The industry has been adversely affected on account of tightening of available foreign currency credit facilities, and is especially vulnerable in a rising interest rate situation.”

The credit rating agency states that diamond companies are facing the dual pressure of low profitability and high working capital requirements. The current market conditions of volatility in diamond prices and foreign exchange rate movements, coupled with inventory pile-up, stretching of receivables periods due to customers’ liquidity problems and higher cost of capital, have weakened the credit worthiness of diamond companies.

Israel Faces Similar Woes :

Shmuel Schnitzer of M. Schnitzer & Company, and a former president of both the World Federation of Diamond Bourses and the Israel Diamond Exchange, says, “There has been a significant drop in the volume of the diamond trade in Israel. Prices also suffered, particularly in the big stones. Banks have made lending norms more stringent as they seemed to be losing confidence in the industry.”

Udi Sheintal adds that “banks in Israel have substantially reduced their total credit lines to the industry and raised the cost of credit.”

With business in the doldrums, the diamond industry opened its ‘third eye’ and looked inward to assess its flawed financial armour that failed to protect it against the crisis.

Introspection of Flaws :

On introspection, diamantaires have spotted serious flaws within their business policies like overstocking, lack of transparency, fund diversion and easy credit facilities for downstream players.

Overstocking :

In 2008, De Beers, the major diamond producer, sought to transform the process of controlled rough supply to the industry into a demand driven one. It thereby released its buffer stocks, accumulated over the 1990s, amounting to nearly US $50 billion, in the market, into the hands of rough and polished traders, polished manufacturers, jewellery manufacturers, distributors and retailers.

Chaim Even-Zohar, noted industry analyst, states that this led to an unprecedented crisis with the diamond downstream pipeline holding more stocks than ever before while the producers held next to nothing. It became a suppliers’ market and resulted in rough diamond availability far exceeding the demand for roughs.

Lack of Transparency & Fund Diversion :

Anil Shah, partner in Venus Jewels says that “besides external factors, the disturbance came from within our trade. There was an inefficient distribution of rough diamonds. Some diamantaires, involved in speculation, overstocked rough and polished stones and now we are witnessing that these goods have flooded the market, disturbing the normal and regular supply of goods as well as impacting prices adversely.”

Agreeing, Kaushik Mehta says, “We saw some serious structural weaknesses in the diamond industry which needed correction.”

He points out that “many companies had diverted their funds from the diamond industry into other sectors, including real estate, commodities and equities. As these markets collapsed, the capital that was funding rough diamond purchases also dried up. Moreover payment terms on polished diamond sales were simply becoming too lenient.

But more critical than fund diversion is the pattern of financing prevalent in the diamond industry.”

Financing Systems Faulty :

In creating a demand-based market, producers led by De Beers, encouraged their clients, the Sightholders, to focus on ‘vertical integration’ or the management of upstream and downstream relationships with suppliers and customers, to deliver better value at less cost to the supply chain.

As a result, today diamond manufacturers borrow finance to buy roughs from mining companies for cash, through ‘auctions’. In about four months, they convert the roughs into beautiful, polished and profitable gems through their expert cutters and artisans, and then sell the same to the buyers and retailers on lenient credit terms.

In each of these three stages of rough diamond procurement, polished production and onward sale, the diamond manufacturer bears the costs; the interest payment to banks on borrowings to buy roughs, maintenance of workers and then extension of easy credit to the buyers, often without any redeemable collateral.

According to Moti Ganz, President, International Diamond Manufacturers Association (IDMA), “We give them the goods as well as offer them long credit terms, often without any redeemable collateral. Diamond manufacturers should no longer bear the burden of the market, which amounts to about 80 per cent of the financing of the total credit that is extended in the diamond trade.

“This way, we are losing money; we’ve put ourselves in a weak and disadvantageous position in dealing with the banks; we’ve nailed ourselves down in supply agreements and credit terms; and we have no tools to assess or even check what our retail clients are going to do. We need to change this by selling our gems for cash, just as the mining companies do, and the retailers should shoulder their own financing,” he says.

“We must try and disengage ourselves from the problems of the other players - the consumers, the retailers, and, yes, even the rough diamond producers - in the diamond and jewellery supply line. We need to change the rules of the game.”

The IDMA president also suggests a business model, already in place among rough dealers.

A Unified Front Needed :

“Ideally, manufacturers must sell goods to the polished dealers - for cash. These polished dealers, who are closest to the market, and know current trends, would provide credit to the retailers. Polished dealers know the market so well that they will only buy from us when they know that the goods bought are needed in the jewellery market and will move through the pipeline at an acceptable rate and pace. This way, banks will treat us more favourably although they may lose some business, about 10 per cent to 20 per cent of profit.”

Tail Problematic :

As a banker puts it, “the problem lies in the tail!” While the bank knows that the manufacturer will repay its debt, the manufacturer cannot be sure whether the retailer will pay back his dues!”

However, this business model, although sound and economically correct, is socially difficult to implement, unless all diamond manufacturers stand as one. Only one unified front can challenge the producers cartel and enable the manufacturers to take control.

Government Bailouts :

With all the introspection going into the running of business, and ways to overcome the downturn, governments have also intervened to provide bailout packages for the diamond industry. In April this year, the US government promised support of US$ 250 million to the Botswana diamond cutting industry through its Overseas Private Investment Corporation in a move to protect jobs in the African country’s diamond cutting and polishing industry. Botswana has also recently secured a US$1.5 billion loan from the African Development Bank, the largest-ever budget support given by the bank, following a slump in diamond exports.

In India, to control the corrosive fallout of the meltdown, the Gem and Jewellery Export Promotion Council (GJEPC) made representations to the government of India and the Reserve Bank of India (RBI) to introduce measures for reviving the diamond industry, one of the major forex earners in the country.

Consequently, the special task force of the RBI recently issued guidelines to banks to help the industry tide over the financial crisis.

Measures to Improve Liquidity :

The task force made recommendations on rescheduling loans and extension of fresh financial facilities, including lending against the stock of polished diamond inventories, which would help to resolve the problem of liquidity. Interest financing of exports has also been made less costly and more convenient for exporters.

Banks have already begun to implement the guidelines. Sarat Mishra of State Bank of India, Diamond Branch, reports “We understand that it is only a matter of time before the downturn abates. There have been delays, not defaults in payment. As per the RBI guidelines, in December 2008, we have allowed diamond traders more time to clear their payments.”

Lengthier Credit Periods :

As most of the diamonds processed in India are exported, banks have extended the pre-shipment rupee export credit to buy roughs from 180 days to 270 days and the post-shipment rupee export credit from 90 days to 180 days, besides an interest subvention of 2 per cent on the pre and post-shipment export credit, up to March 2009 subject to a minimum annual interest rate of 7 per cent.

Lending Against Stocks : Valuation Needed

Mishra also disclosed that the diamond industry is capital intensive, with high inventories and needs critical injections of working capital. Therefore, banks have started to extend loans to traders against their inventories. This was one of the demands made by traders to ensure liquidity, which was cleared by the RBI, subject to appropriate valuation by an accredited valuer.

However, when questioned, Mishra said that nobody undertakes a valuation exercise, which would prove to be expensive as the gemstones in India are small and numerous. Instead, banks lend to traders against inventory, the value of which is based on a statement made by the trader on the import of rough versus the export of polished gems. The banks may conduct a random check but this actually happens rarely.

Belgian Banks More Cautious :

In Belgium, however, banks are more cautious. They have never lent against stocks, until sometime ago.
For instance, to improve the liquidity position of diamond dealers, Antwerp diamond banks have agreed to provide a temporary, additional financial mechanism, in response to the representation made by Antwerp World Diamond Centre (AWDC), on behalf of the Antwerp diamond dealers.
The diamond banks in Belgium, including ABN Amro, Antwerp Diamond Bank, State Bank of India and ICICI Bank have agreed to provide new credit facilities up to a maximum of one billion euros, for a period of two years on the basis of stock collateral. To secure the position of banks, AWDC would be in charge of the valuation of securities and the transparency of the operations.
Brigitte Seegers, from the ABN Amro Press Office confirms, “We have created some logical solutions to the credit crisis. We are reviewing and shall put into operation the Belgium Diamond Fund. This is a temporary lending facility being supported by the CBFA, the Banking, Finance and Insurance Commission in Belgium. It is a form of temporary stock lending, extending up to two years or three years, whereby the stock lies with a designated third party owned by the government. We shall offer credit against stock.”
However, what is not certain is that when banks lend against diamond stocks as collateral, will they be allowed to take the value of the gemstones on their books of account? The national rules of credit would have to be amended to allow that.

The Prognosis :

Diamantaires who have managed to survive this far through the global economic crisis, believe that the worst of the recession is over. They also understand that the crisis has precipitated some corrections long overdue in an over confident industry.

Momentum & Satisfaction :

Kaushik Mehta marks the turn-about, “Business activity is picking up momentum.”
A similar sentiment is echoed in Israel. Shmuel Schnitzer states that “The world economic crisis impacted bank financing in the diamond industry. But slowly, things are returning to normal.”
Brigitte Seegers from ABN Amro too confirms this. “We predict recovery of the industry by end of 2009 or beginning of 2010. ABN AMRO has a 30 per cent market share in the diamond industry world wide and it is thus the largest bank in this business. At the moment we see the market stabilizing. The market is also quite strong, due to the historically low interest rates. We expect the industry can manage itself through active stakeholder management and discipline on costs.”

ABN’s Interest in India :

Interestingly, reflecting its upbeat stance, ABN Amro Bank has recently approached the RBI for a banking license in India, to continue operating its diamond business here. Although ABN Amro has been in India since the 1920s, with reportedly 31 branches and 10,000 employees, it needs a fresh licence as its ownership records have changed. In October 2007, ABN Amro was acquired by a consortium of the Royal Bank of Scotland (RBS), Fortis and Banco Santander and its India business got transferred to RBS. ABN Amro’s diamond and jewellery business in India is estimated around US $637 million.

Return to Glory :

Even bankers in India agree that it is only a matter of time before the industry returns to normalcy. Says Sarat Mishra, GM (RM) of State Bank of India, Diamond Branch, “We are not living in an isolated world. The problems of the diamond industry are genuine and we are doing all we can to tide over the crisis. We give it another six months to a year to stabilize and return to glory once again.”
“Day by day we are keeping our focus on the long term emotional value of diamonds. After all, celebrations will continue as long as the human race does,” says Mishra. Others too believe that the downturn has bottomed out and a recovery is in the offing.

All's Well that Ends Well !

Sooner or later whenever that happens, it is true that the crisis will encourage price transparency and corrections within the diamond industry with the silver lining that only the very strong will come out healthy, wealthy and wise!

An instance of Injurious Recession …