How profitable has the gems and jewellery sector been recently? How exposed are banks to the sector? These are questions that arise in the wake of the recent scam that has rocked the sector.
The accompanying Chart 1, with data taken from Centre for Monitoring Indian Economy, shows the performance of the sector in the last five quarters. Net sales of the gems and jewellery sector declined 15% year-on-year for the December 2017 quarter. This is on a low base when net sales had increased a mere 4.4% during the demonetisation quarter.
Profitability was far worse. December 2017 quarter earnings before depreciation, interest and tax (or operating profit) dropped by nearly three-fifths.
The sector has been under pressure as working capital was blocked owing to refund delays during the implementation of the goods and services tax.
Interest cover, a measure to determine the ease with which companies can pay their interest obligations, too has deteriorated to 1.7 times last quarter from 3.2 times in the December 2016 quarter.
In the light of the recent fraud involving billionaire jeweller Nirav Modi and Punjab National Bank (PNB), it is likely that banks may be wary of funding the sector.
“One has to differentiate between the current fraud (PNB related) and the performance of the gems and jewellery sector which are not related," says Madan Sabnavis, chief economist at CARE Ratings Ltd.
Nevertheless, the fact that interest cover for the gems and jewellery sector has been deteriorating over time is hardly a desirable situation especially if banks turn overcautious and tighten liquidity to the sector, as a reaction to the fraud, added Sabnavis. Of course, that might pose a further challenge to this sector.
But, there is a silver lining. According to Kotak Institutional Equities, exposure of 18 banks’ overall book (12 public sector banks and six private sector ones) to the gems and jewellery sector is only about 1%. Chart 2 has details for some banks from Kotak’s sample.
Also, for now, the problem appears limited to PNB.
“Our observations and discussions with banks/experts give an impression that the impact of the fraudulent and unauthorized transactions appears to be bank specific," added the brokerage firm in a report on Thursday.
About PNB, analysts from Jefferies India Pvt. Ltd said in a report on 21 February, “Along with the new regulation on stressed assets (upfronting of NPL recognition) and disarray in trade-finance (lower management bandwidth), next two quarters look dismal - low growth and higher provisions. Assuming PNB bears the entire cost of the alleged fraud, the post-tax impact on capital is 170 bps, which necessitates capital infusion of Rs5,500 crore to just about meet CET 1 / AT 1 / CRAR norms (more AT1 bonds may be required, but in case of a credit rating downgrade, this gets tougher)."
For the sector as a whole, the Kotak note adds: “Off balance sheet risks have declined over the past decade but this event would see banks further tightening their operations, making it a bit more expensive for corporates."