Dubai Topped $10 Billion in Diamond Transit Trade in 2005
April 06, 06Polished and rough diamond transit trade through the world’s premier diamond offshore jurisdiction exceeded even the wildest expectations in 2005. Combined imports and exports totaled $10.59 billion. In carat terms, the figures are truly staggering: the combined turnover (in and out) of polished diamonds exceeded 56 million carats; rough was well over 71 million carats. Even though there is a buoyant domestic diamond jewelry market, 94 percent of all carats (rough and polished) imported are being re-exported.
Half a decade ago, there was hardly any diamond business in either the free trade zones or in Dubai itself. Its rough diamond exports to Antwerp grew from a meager $4.2 million in 1998 to $1.2 billion in 2005(!). Ever since De Beers chairman Nicky Oppenheimer gave his stamp of approval to Dubai in early 2004 when he demonstratively recognized it as “rapidly becoming a vibrant and growing diamond trading and diamond financing centre,” Dubai’s rough diamond imports have tripled in value within three years, while exports doubled.
Any rough diamond parcel traveling in transit through Dubai finds its value “mysteriously” increased at the exit gates, but the "party" is over. The artificial value addition in the rough trade has gradually been reduced, partly through the tougher policies of Dubai Multi Commodities Center (DMCC), the Dubai Diamond Exchange (DDE), the Kimberley Authorities, and the firm hand of bourse CEO and Kimberley administrator
If, for example, in 2003 the rough “passing through” doubled in value, in 2004 the value addition was 84 percent; last year it was further reduced to 63 percent. That’s no mean achievement. It is the trend that counts, and the trend is the result of the gradual implementation of a sensible policy.
The polished business is more difficult to manage, and polished has become Dubai’s growth business of choice. In polished, of course, we see a reverse trend: the per carat value of imports is higher than the value of the subsequent re-turn exports (“sales”) to its destination. As we have noted before, the offshore rough and diamond trade not only aims at tax avoidance (in the cutting and trading centers) or money laundering in the classical sense, but also to facilitate accommodating the pressures by rough diamond suppliers (mostly De Beers) for their clients to demonstrate “financial strength.”
As parameters showing financial strength have become important comparative scoring factors in the competition among clients and future clients of De Beers to obtain a Sight, Dubai has given rise to a fictitious creative accounting industry, enabling diamantaires to show De Beers impressive equity growth and massive growth in profits. It is comforting, however, that what appears to represent massive industry laundering on a multi-billion dollar scale is actually “virtual laundering” – as no criminal money is involved. Accounting profits are created; not necessarily representing real money. Moreover, old money, kept in succession for many generations in offshore accounts, finds a point of entry to become part of the stated, transparent and official business capital. It replaces “back-to-back” loans with “no loans” – a healthy and needed development in an over-indebted industry. Nevertheless, the thin line between legal and illegal may well be transgressed – and not all virtual laundering is so virtual.
Moreover, the Indian government has now awakened to realize that it is losing out on massive tax revenues. The Dubai transfer pricing mechanism is allegedly used to gain access to attractive government incentives rewarding rapid export growth. Six Mumbai-based diamond exporters, including at least one DTC Sightholder, with a combined turnover of $1.8-$2.2 billion are being investigated for indulging in circular trading to take advantage of the government’s “target plus” scheme.
The income tax department, the Enforcement Directorate and the department of revenue intelligence are conducting the investigation. A government official told Mumbai’s Business Standard that, “the Mumbai companies were routing cut and polished diamonds between India and Dubai. These firms buy diamonds and undertake operations like sieving and sorting in Mumbai to fulfill the minimum value-addition norms.”
The article continues, “Within a few hours, these diamonds are sent to Dubai, where they are displayed on the shelves for a few hours, sold and returned to Mumbai.” Officials told the newspaper that the “companies came under the lens of the investigative agencies because of a huge increase in their turnover. It was also found that there was no change in the caratage of diamonds, despite the reported value-addition.”
The (reduced import duty) incentives scheme appears to have triggered an almost 20 percent increase in polished diamond exports from $10.3 billion in 2004 to $12.3 billion in 2005. The “circular” nature of the trade is seen in both rough and polished. Imports of polished diamonds into India in 2005 totaled $3.6 billion, a 71 percent increase over the $2.1 billion of 2004. “Thus net polished diamond exports were actually below our rough diamond imports, which just topped $9 billion in 2005. Allowing for a 20 percent to 25 percent value addition on the processing of the rough, and allowing for a $1 billion domestic market, clearly a few billion dollars have gone missing in India,” says a Mumbai diamantaire who clearly was not amused. “Some of us have gone mad,” he adds.
In the past three years, Dubai’s free trade zone imported 96.5 million carats of rough and exported 93 million carats, which is virtually the same volume. As the annual mining production of natural diamonds, industrial and gem qualities combined, come to some 160 million carats, it seems that 25 percent - 30 percent of the world production passes Dubai before they reach a processing destination. In the three year period, the equivalent of 77 percent of import value has been artificially created – that is well above $2 billion of “new money”. Let’s look at the figures:
As the movement of goods through Dubai has a plethora of different reasons, it is significant to recognize both their sources and destinations. It is noteworthy that 45 percent of the rough comes from Europe (UK, Belgium, and Switzerland). Much of these goods are returned to Europe, though the majority is re-exported to India. Without a “transfer pricing” element, these goods could have been exported directly to their destination. As most parcels are simply re-invoiced and shipped further, the suggestion that goods are being “resorted” is wishful thinking in most instances. The rough imports into Dubai from India are mostly immediately returned to its country of origin.
Unlike the rough coming from Europe or the U.S., which are not rough diamond producing countries, the diamonds from Africa pass through Dubai mostly to avoid the export taxes in the country of origin. Here the Kimberley Process authority needs skills and judgment in what prices are “reasonable” or “unreasonable”. In the early years, the DMCC authorities actually shipped a number of parcels back to their African origin countries because it categorically refused to accept the gross under-valuation, which it found to be wholly inconsistent with the general image of the Dubai rough diamond trade.
As I have wrote in the past, the DMCC has formally raised the problem of under-valuation of incoming shipments from certain countries. In particular, it has questioned the value presented on certificates coming from Tanzania, Angola, the Republic of Congo, the Democratic Republic of the Congo, and, to a lesser extent, India. Shipments from these countries have been consistently valued significantly below the valuation that the U.A.E. Kimberley Process authorities believed was accurate.”
The Dubai and Antwerp markets are familiar with the following argument of a major rough exporter from a prominent producing country Assume that on a $10 million parcel the export tax due to government (at 5 percent) is $500,000. Officials agree with the exporter that if he makes a “facilitation payment” of $200,000, the parcel will go out valued at merely $1 million. In such and example, where the export tax would be only $100,000, the exporter gets a $200,000 benefit. The exporter claims to have no choice if he wants to continue buying diamonds in that specific country. “If I don’t accommodate these officials, they will work with someone else who will,” he reportedly laments to an associate. When the Dubai KP office refuses to accept these valuations, the exporter counters, “if you don’t like my business, I’ll take it to Hong Kong.” If they check the value with the country of origin, the answer is, “This is our value; how dare you to question our estimates.”
The fact that the outrageous value additions have gradually seen some moderation shows that the Dubai Kimberley authorities are successfully convincing traders to report more reasonable values – whatever that means. The rough export picture looks as follows:
While some 45 percent of rough originates from Europe, an even heftier 71 percent of the re-export go back to Europe, underscoring that it solely involves “financial manipulation”, serving no other utility. Only 7 percent goes to China, presumably for processing, and a further 19 percent to India, also, presumably, for cutting and manufacturing.
Some 95 percent of Polished Imports are Re-Exported
Though in the past few years the rough diamond business was very much the focus of attention, the “real action” seems to be in the polished trading business. Between 2003 and 2005, carats import increased over 800 percent. In value terms, imports increased from $858 million to $3.74 billion. Even steeper growth can be seen on the re-exports of polished, which recorded well over a 1000 percent increase in carat terms in just two years, matched by a similar value growth.
As the polished diamonds trade statistics provided by U.A.E. are still preliminary, we would like to get further verification before jumping to too many solutions. Prima facie the transfer pricing manipulations seem less profound in polished – but this is harder to verify and it isn’t clear what part of the imports are truly consumed domestically. The cheap per carat values are not generally associated with the consumers in the Gulf countries, but, we were told, there exists a large market for such goods in the Arab world.
The interaction with India is a reason for concern. India exported some $1.35 billion worth of polished diamonds to Dubai in 2005, at an average price of $201.40 per carat. At the same time India imported (from the whole world) some $3.7 billion worth of polished, apparently mostly from Dubai. The figures are yet unclear, but Indian authorities confirm that polished diamonds imports into India grew by 70 percent within one year.
At this point the Dubai story seems mostly an Indian story. Recently, it was announced that India’s income tax officials decided “to turn the heat on gems and jewelry sector after the industry failed to make realistic income disclosures.” Mumbai’s chief commissioner of income tax has indicated that at recent raids, “the department unearthed huge concealment of income. In some forms, the concealment was to the tune of 50-100 percent.” India’s tax regime has very specific rules on transfer pricing. And while Dubai's $10 billion 2005 performance will reverberate in other regions in the world, it will mostly be felt in India. This story will continue. Stay tuned.