State Of The Economy 2016

Roughing it out

Surat's diamond units are recovering from the industry's worst slump in four decades

Absolutely hopeless.” Seated in his sun-lit, spacious office on the top floor of an unassuming multi-storeyed building in Surat’s former textile hub of Kapodara — the name derived from the Surti word for cloth, kapad — Shailesh Zadafiya doesn’t mince words when asked how 2015 has been for the diamond industry. From a country that neither mines nor consumes the stone in a big way, Surat supplies nine out of 10 polished diamonds worldwide. But this Rs.90,000-crore pure processing industry has lost a little bit of its sparkle in the last year-and-a-half, with exports dipping by 14% Y-o-Y to $10 billion between April and September 2015. Apart from several interrelated global factors, manufacturers here blame irrational local exuberance and financial impropriety for the current mess.     

“Last year was one of the worst years for the industry and this crisis was mostly created by our own people,” says Sevanti Shah. Venus Jewel, the company Shah co-founded in 1969, is one of several Indian sightholders — players with a minimum turnover of Rs.1,000 crore-5,000 crore — on mining group De Beers’ Global Sightholder Sales list, which means it can purchase rough diamonds in bulk. Although most sightholders run their own manufacturing and polishing units to burnish this crystalline raw material into a gleaming 56-facet diamond, there are several manufacturing and jobwork units downstream that either source and work on the material themselves or work on a contract basis for the biggies. This, Shah says, is also where the current slump stems from, in part. 

Unreasonable appetite
“Some people wanted to grow very fast and sourced more raw material than necessary. The demand for rough diamonds shot up, leading to clearing of existing mining stock, increased mining, overproduction and a consequent rise in rough prices,” he explains, adding that the spurt had little to do with consumer demand. So, while manufacturers in Surat were paying more for rough diamonds, polished prices went down due to the oversupply and scant demand on the ground. “Demand and supply — the key economic metrics — were ignored. In part, bankers were also responsible, as they kept releasing credit indiscriminately in certain cases,” he adds. Zadafiya, partner in the family-run Zadafiya Group, says many people diverted bank credit to real estate, while Kalpesh Vaghasiya of Palak Designer Diamond Jewellery says some units might have used funds intended for technological improvement, raw material purchase or infrastructure development to maintain liquidity instead.

After a few high-profile closures and insolvencies in the local market — Godhani Gems among them — banks started tightening credit norms, and deserving SME units in Surat were at the receiving end. Given that the global economy is running out of steam and factors such as dipping discretionary spends and increasing austerity measures in emerging economies like China are in play, diamond miners such as De Beers and the Russian ALROSA seem to have been misled into forecasting a larger demand for polished goods due to the sudden demand for rough stones. Some also blame the overexpansion by Chinese companies for this imbalance, since that created a momentary demand for polished goods. “To prevent such a situation in the future, miners need to conduct market intelligence, assess the requirements of each market and only then release prices and quantities into the market,” says Praveen Shankar Pandya, chairman, Gem & Jewellery Export Promotion Council (GJEPC), a quasi-government undertaking. 

Meanwhile, Surat paid a heavy price for all these indiscretions. The combined size of default from the industry has reportedly touched Rs.3,000 crore and close to 200-350 units have been forced to shut down, affecting thousands of workers. While some were absorbed in the local textile industry, a large proportion have reportedly packed up and left for their home states of Bihar, UP, Rajasthan and Chattisgarh — only a small proportion are locals, largely from central and north Gujarat. “About 10% units have shut down. These are mostly unbranded ones, running as single-room operations, with 10-15-odd polishing tables,” confirms Jayeshbhai Patel of Atmanand Gems. “Such units handle jobwork for bigger companies like ours, and when things go bad, they are the first casualty.” 

Patel’s company operates out of Surat’s Pandol area, home to perhaps the largest concentration of the cluster’s smaller diamond units. Atmanand Gems has weathered the storm so far by shrinking production. “We asked units to bring down production in a way that workers weren’t impacted too much,” says Dinesh Navadiya, president, Surat Diamond Association, and regional chairman, GJEPC. In step, rough imports dipped by 26% in 2015.

Bitter, better
“By reducing inventory, we were able to revive the cluster’s confidence. Since Diwali 2015, we have been able to increase — or, at least, maintain — production,” says Pandya. Players in Surat’s diamond value chain have dealt with these adverse circumstances with their own brand of Gujarati pragmatism. Take Patel’s Atmanand Gems, which was only able to meet 60% of its sales target last year. Since rehiring skilled workers remains a challenge in this industry — a lesson learnt the hard way after the 2008 financial crisis — Patel says he tried to trim costs instead, retaining as many people as he could. “We cut salaries as much as possible, although we didn’t cross the 30% figure. Those at Rs.30,000-40,000 levels were hit, because for the ones at Rs.10,000-15,000 levels, we actually hiked pay by Rs.1,000-2,000 to prevent attrition.”

But this isn’t enough incentive for the close to 500,000 diamond workers, as this slump has shaved off any salary gains they made post-2008. When the industry experienced an upturn between 2010-14, wages went up to Rs.18,000-20,000 from Rs.9,000-10,000. Zadafiya says workers expected hikes of 10-15% each year. “And yet, people would leave at the slightest provocation.” In addition to shrinking production, Patel says he bore some stock loss to reduce inventory, but was able to recover some of this once the market improved after Diwali. “Diamonds are not like, say, aluminium — I can’t pass on price hikes to the customer. The only way the industry situation can improve is if real demand revives.”    

Apart from shrinking discretionary spend, there are other factors affecting end-user demand. One is the rising popularity of personal technology goods like the iPhone, which is both high on utility and aspirational value. The second is the threat of synthetically produced — but frighteningly similar — chemical vapour deposition (CVD) diamonds. “While diamond variants such as cubic zirconia and Swarovski have always existed, CVD created a dent in demand last year since it rattled the consumer’s faith in the exclusivity of diamonds, given how it passed key tests of strength, light and firing. But with units installing testing machines at a cost of Rs.10 lakh-12 lakh, buyers are feeling reassured.” Industry veterans were firm in their insistence that CVD diamonds would, at most, end up in a parallel market. Says Atmanand Gems’ chairman — and Patel’s uncle — Khodabhai Dungrani, “As things stand, the profit margin on CVD diamonds is not big enough for us to manufacture it. And for just a 10% difference in the final price, who will buy the synthetic product?” 

Zadafiya agrees. Having adjusted both his workforce and production to the vagaries of market demand, his 1,300-worker firm is in a stable position today. He pegs the Y-o-Y hit on sales to about 20-25%, given that his unit did not run to full capacity. “We changed the production pattern by reducing the amount of work given to workers and changing the pieces we were working on (to larger, better-margin stones).” Since the group’s capex plans are on hold for now, Zadafiya is glad he invested in technology — machines that can map and cut diamonds — when the going was good. Zadafiya does hope the government would make the industry tax-free, as it briefly was in the nineties. “This is a 99% export industry. Jitna import aata hai, utna labour add karke export ho jaata hai. So, tax-free hota toh achcha ho jaata.” 

SMEs have also had to make their own set of adjustments. Chirag Virani, director of B Virani & Co, which does jobwork for De Beers’ sightholders, says he was forced to minimise fixed expenses to survive. “We cut down on hours. If you only have 40% of stock to be processed, you cannot run at 100% cost. The market has revived after Diwali, so now we are back to our normal capacity.” Virani says the company will increase hiring if demand holds up. Given the pressure on margin in the past decade or so, Virani also foresees a move to consolidate on part of the miners, which might eventually price smaller units out of the business. “Three or four miners such as De Beers, Tiffany and Chow Tai Fook today control the entire value chain; they have their own mines, manufacturing facilities, retail — everything. So, small manufacturers won’t be able to survive.”   

The only relief for the units currently is the cushion provided by the dollar. “In terms of exports, stronger dollar is an advantage. If it falls, labour costs rise, but we can’t pass on the hike to customers,” says Zadafiya. While larger companies have standardised their salaries in dollars to protect themselves from fluctuations, smaller units work in rupees. And although this can be recovered at the time of sale, currently, even that is a challenge. 

The diamond hope
However, not everyone in the cluster is on edge. Vaghasiya, partner at Palak Designer Diamond Jewellery, for which finished diamonds are raw material, says his firm has seen 30-40% Y-o-Y growth recently thanks to growing consumer appetite. Although concerned that mandatory PAN cards for diamond purchases above Rs.2 lakh will keep people away, he is hopeful about demand, taking solace from Valentine’s week sales for Palak’s Arianna brand. The company, which deals directly with wholesalers, has doubled capacity at its four factories across Surat, including one in the old city area of Mahidharpura, where 350 employees are hard at work on finished pieces. Vaghasiya plans to invest capex in creating brands and the customisation of watches, pens, cufflinks, etc., to generate demand from the consumer end. 

That entrepreneurial spirit is displayed by one of Surat’s Goliaths as well. About an hour’s drive from Surat station is Hari Krishna Exports’ sprawling new facility at Ichhapore, which houses 4,500 employees. The complex has the latest in technology, including a pneumatic tube system — costing Rs.3 crore — that transports stones instantly from one end of the 350,000 sq ft building to the other. With an office at the Bharat Diamond Bourse at BKC, and two others in Surat, the company set up this facility as part of its capex in the past three years. Started in 1992 by Savji Dholakia and his family, Hari Krishna Exports touched $1 billion in turnover in 2014-15 and is also a De Beers sightholder.     

If you have a vague memory of the company’s name in the news, you wouldn’t be wrong. In October 2014, Hari Krishna Exports hit the news for giving away 570 jewellery sets from its Indian brand Kisna, 207 flats and 424 cars to employees as part of a loyalty programme. “The diamond industry cannot always remain stable. Mandi aayegi ni aayegi, tezi aayegi ni aayegi, up-down rahega ni rahega. So, this year might have been bad, sales might have come down to 85%, but I take it in the positive sense,” says chairman Dholakia. He explains that since the quantum of work did change over the past year, the company utilised idle capacity by retraining workers in different skills. “We didn’t cut staff because we don’t keep them on fixed salaries — we link pay to performance. But yes, salaries might have been affected because the value of the work we do has reduced.” He explains that the company had big plans for this fiscal’s loyalty programme as well, but may have to defer that in the light of the state of the industry. 

Dholakia’s real worry is how the smaller businesses in the cluster will survive. “People are hesitant to invest a lot in training workers. But that means ki chote log develop nahi ho paayenge.” For now, Hari Krishna has no expansion plans and is focusing on firming up business in order to recover profits. “We have changed our whole system to COD — we no longer take credit from the market. We have made several alterations to business, so, hopefully, FY17 will be better for us.” 

Cash-only is a good precedent in an industry where manufacturers get squeezed from both the buyer and supplier side. Shah of Venus Jewel, in fact, was an early adopter in this field. “In value terms, business has suffered, but we have our own way of working and were personally not affected. In fact, we hiked wages for our 1,400 workers last year.” There has been no retrenchment, with production lowered by 25-30% instead. “Inefficient workers are retrained in-house. We were the exceptions even in 2008, when we didn’t close production for even a single day,” he explains. For this feat, IIM-A had featured the company as a case study in its periodical Vikalpa

The only infrastructural challenge that these firms grudgingly mention is domestic and international air connectivity, which is an issue since buyers and sellers need to travel in and out of the cluster frequently. Although Hari Krishna runs its own charters and though the local diamond association and several big companies have pledged bank guarantees and a minimum amount of business to the airport authorities, services are still left wanting.

Of course, the focus of industry associations at this point is solely on how to revive demand and engineer an assured supply of finance to MSMEs. “Banks need to have specialised diamond banking facilities. If IndusInd Bank could purchase RBS’ entire diamond portfolio — worth $1 billion — in 2015, why can’t other banks make money?” reasons Pandya of GJEPC. Apart from plans to designate a special notified zone for diamond units, Pandya plans to increase generic marketing so that consumer sentiment can be revived. Navadiya adds that the government could also step in through NMDC and strike deals with the miners in order to regulate the supply of raw material to smaller units. 

For now, as he looks out at the city sprawled out in front of him from his office terrace, Shah of Venus is optimistic. “People have become more disciplined — whether out of compulsion or otherwise — and if they work this way, there won’t be a problem. The people in Surat are nice, the work environment is nice, the climate is nice. I came here in 1965, soon after my matriculation. Good or bad, I have never left since,” he smiles.