Fitch Ratings’2010 outlook for India’s gems & jewellery sector is negative to stable, with a slow improvement in liquidity and credit profiles for many issuers. This is primarily a reflection of slow recovery in domestic and international demand, and relatively low currency volatility leading to better realisation by the industry operators. India-focused players like BC Sen & Company Limited (eBBB-(ind)/Stable) are likely to show stable credit profiles, driven by correspondingly stable demand growth in the Indian market.
Fitch expects a significant recovery only towards mid-2010 for diamond polishers which are export-focused, whilst a recovery for export-oriented gold jewellery manufacturers is likely to take longer – in line with the generally expected economic recovery in the respective markets. The large inventory and receivables built up during the downturn are also likely to ease – with many exporters having already liquidated a portion of their inventory, and an improvement in the collection periods, both of which had ballooned during the downturn. Fitch notes that performance remains contingent upon a sustained economic recovery in these key markets, and remains exposed to a ‘double-dip’ recession in these regions.
Jewellery exports have started to fall sharply from Q409, primarily due to the impact of the credit crisis on the Middle Eastern markets. The value of jewellery exports declined by 22% during September-November 2009 versus the same period the previous year -despite higher gold prices and a favourable exchange rate, which implies an even sharper volume decline.
Diamond polishers began to show positive growth from Q309, due to the slow recovery in retail demand from key markets like the US, the EU and Asia (including China). However, part of the growth was also due to the weaker Indian rupee against the US dollar.
Fitch believes that the bigger players will continue to drive the recovery in the
short- to medium-term, while the smaller players would only really be expected to
grow over the longer term.
The government continues to provide a favourable stimulus to support the industry – including interest rebates, and the extension of credit periods and export duty benefits available to the sector. The interest rate benefit will continue until March 2010.
Diamond exports from India have substantially recovered with the onset of gradual
global economic recovery, although a part of this increase is due to the weaker rupee. The favourable exchange rate, coupled with higher demand and government incentives, has resulted in improving liquidity for most diamond processors and jewellery makers.
Liquidity Pressure to Ease
Fitch expects the industry’s tight liquidity situation to ease during 2010 – with the ongoing liquidation of inventories, coupled with the fact that a substantial proportion of the industry’s bad debts were written off during 2009. This is aided by the fact that many companies focused on improving their collection mechanisms during the downturn. Better terms for working capital financing will add to these positives.
Demand – Growth Backed by Global Recovery
The performance of the Indian gems & jewellery sector is driven primarily by export markets, which generate nearly 40% of demand. Key export destinations for diamond exports are the US and EU; followed by South-East Asia, China and the Middle East. However, the largest market for jewellery manufacturers remains the Middle East, especially for gold jewellery which accounts for most of India’s jewellery exports.
Demand for gems and jewellery has surged with the global economic recovery, and
further increased in Q409 due to the expectation of better Christmas and New Year
sales in key markets. The industry also increased its focus to emerging nations such
as Russia, China, Hong Kong and the Middle East.
Encouraged by the demand scenario, the industry has started to increase production and capacity utilisation. Fitch observes that the companies with geographically]diversified revenue streams and higher exposure to East Asian markets are relatively less vulnerable, and continue to perform better than those focused purely on the US and EU.
In addition to geography, the product profile also shifted towards gold jewellery with the higher demand from the Middle East. However, in Q410, exports of gold jewellery dropped while the export of diamonds increased . especially in December 2009, which underwent an approximately 45% increase to USD1.9bn from USD1.3bn in December 2008. Key raw materials like rough diamonds, gold and silver surged in value and outpaced the growth in sales, putting pressure on operating margins.
Margin Pressure due to High Raw Material Costs
Access to good-quality rough diamonds remains a critical success factor for the sector. Those companies with strong sourcing relationships (eg holding sightholder status with the Diamond Trading Corporation (DTC) and other large sources of roughs) benefit from access to better-quality stones, especially in the current scenario of production cuts from diamond mines. With the large supply cuts, coupled with the slow demand recovery, prices of roughs have risen faster than polished diamonds, thereby compressing the gpolishingh margins for Indian players.
India-focused jewellery manufacturers are able to pass on gold price increases to their retail customers which benefit their margins during periods of rising gold prices due to their inventory holding periods.
Currency Volatility
While many companies have attempted to mitigate the volatility by booking sales at
the time of purchasing roughs, the fluctuations have resulted in substantial exchange rate losses for many players, which have put further pressure on margins and credit profiles.
In 2010, the depreciation of the rupee and more stable exchange rate movements
are likely to lead to better export realisations than in 2009. From Q310, the rupee has appreciated by approximately 9% to endQ410. This will result in lower export earnings for companies with unhedged export sales.
Continued Government Stimulus
The Indian government supported the industry during the downturn, providing interest rate concessions and extending export benefits for the sector. The government allowed interest rate rebates of 2% (subject to a minimum interest rate of 7%), which will continue up to 31 March 2010. It also extended the duty drawback benefit for gems and jewellery exporters, in its 2009 foreign trade policy.
It further increased the pre-shipment export credit period (from 90 to 180 days) and post-shipment export credit period (from 180 to 270 days), allowing for the longer inventory and receivable cycles faced by the sector. In addition, softer benefits like the establishment of diamond bourses were also inducted.
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