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The Duty Debate - A Vicious Circle
From a heavily controlled sector in the 1960s and 1970s, India’s diamond trade came a long way with steady liberalisation over the last few decades of the 20th century. The abolition of duty on import of rough diamonds in 2002 was followed by a gradual lowering of the cess on polished, culminating in its final abolition in 2007. The long cherished dream that the world’s largest manufacturing centre had of maturing towards a key trading centre seemed to be finally within reach.
By: Diamond World News Service
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Feb 20 2012 1:07PM
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Reference: 6745  

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Now, with the government reinstating a two per cent Customs duty on import of polished in mid-January 2012, the obvious question is – has the wheel turned full circle?

On the surface it may be seen as a return to the days of a controlled regime. But a more careful analysis indicates that the move is aimed at curbing a rather dubious practice indulged in by a small section – circular trading or round tripping, through which cheap export credit is raised by continuous export-import-export of the same parcel.

Stephen Rego unravels the story of why a duty that was first abolished had to be re-imposed, and talks to leading members of the trade to understand its implication for the Indian diamond industry.

A little over a decade ago, the US, the world’s largest consumer of diamond jewellery was also the single largest export destination for cut and polished diamonds from India. In 2000-01, as much as US$ 2,144 mn of the total of US$ 6,186 mn of polished exported from the country went to the US market, accounting for a share of about one-third of total exports. By 2010-11, at just over US$ 3 bn, the US share had fallen to a mere 11 percent.

Today, it is Dubai that has emerged as the main destination for polished from India. In 2000-01, the Middle East centre accounted for polished worth US$ 258 mn, a share of less than five per cent of total Indian exports. The figure shot up to over US$ 3 billion in 2007-08 and touched US$ 4.5 billion in 2008-09. By 2010-11, the same destination was not just the largest centre for Indian polished, it accounted for a whopping 47 per cent of the total exports of diamonds, or over US$ 12 bn worth of polished.

Even allowing for a significant increase due to the emergence of the Middle East region as a large diamond consuming market and the rise of Dubai as an important trading hub, there was definitely something extraordinary about this phenomenal rise.

Rise of Polished Imports
Though not exactly parallel to this,another notable trend that emerges is the steady increase in the value of polished imports. From a level of US$ 5460.61 mn in 2007-08, the figure moved to US$ 8883.06 mn in 2008-09, US$ 11609.63 mn in 2009-10 and a massive US$ 20774.38 mn in 2010-11. Once again, taken at face value, this may appear to reflect the significant growth in the consumption of diamonds in the domestic market and a rise in the volume of trading taking place within the country.

The reality however, is a bit more complex, and begins to emerge if one shifts focus from gross to net exports. While gross exports of polished were US$ 14605.27 mn in 2008-09, they rose to 18237.56 mn in 2009-10, and zoomed to US$ 28251.92 mn in 2010-11, net figures were substantially lower at US$ 5722.21 mn, US$ 6627.93 mn and US$ 7477.54 mn, during the same period. It should be clarified that the entire value of polished imports cannot be attributed to dubious deals, since goods do move back and forth even during normal trading. Nevertheless, the huge gap between gross and net exports is certainly not a ‘normal’ phenomenon!

The take-off point for this new trend can, in fact, be easily traced to May 2007 when the Indian government abolished the then prevailing three per cent duty on the import of polished diamonds. This was in reaction to a constant demand from industry bodies ever since the late 1990s when the country emerged as the unchallenged leader in diamond manufacturing, and set itself a target of developing into a trading centre as well. The government had been liberalising the trade in diamonds for over a decade prior to that, granting exporters various concessions, and abolishing duty on import of rough in 2002. The May 2007 order of zero import on polished was seen as the final frontier being scaled.

Exploiting the Loopholes
Things however, turned out quite differently. Picking on a window that the policy ad opened, a few companies, many of them newer entrants to the business, exploited the loophole to raise funds through cheap export credit by exporting, importing and cyclically re-exporting the same parcel of polished. This circular trading, or round tripping, gathered momentum over the next few years, resulting in significant distortions in India’s import-export figures.

Alarm bells began ringing among various sections of the trade as the industry emerged out of the 2008-09 crisis, and during a presentation made at the GJEPC’s International Diamond Conference, Mines to Market 2010, Rusell Mehta, COO, Rosy Blue drew attention to the “divergence between gross and net exports”, which, he emphasised, “could not be explained by trading alone.”

Mehta’s candid observation became the focal point of the panel discussion that followed on “Crucial Challenges to Moving Ahead”. The panelists unanimously agreed that the export figures for polished diamonds was not a real reflection of actual manufacturing and exports, and argued in favour of transparency, self-discipline and some informed government intervention.

“There is lack of believability in our numbers. There is an inherent sense that in this industry, people are doing things that might not quite be right,” Rohan Shah, a panelist and managing partner at Economics Law Practice, a Mumbai-based law firm specialising in international trade law had said. By this time, banks financing the diamond trade had also begun to get nervous, particularly after having to deal with a few cases of bankruptcies and some loans being converted into Non Performing Assets.

At the same conference, A P Verma, deputy managing director, State Bank of India, even raised questions about some of the practices adopted by sections of the Indian industry and called on the diamantaires to be more transparent and open in their transactions with the banks. He offered support to the industry but called for reciprocal action from the other side as well.

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