The heads of Russia-based diamond cutting operations are not the most optimistic kind of people. Rather, they give the impression of purposeful and tired fanatics never getting younger while solving persistent problems - unlike cheerful managers skimming the cream off the market, especially in times of inflating ‘bubbles’ or recovery from the recession, which took place in the first half of 2016. Partly, the reason for this lies in the industry itself - a rough ‘bubble’ in the absence of correlation between rough and polished prices forebodes nothing good for diamond cutters. But this year, diamond manufacturers based in Russia have a new cause for concern, which is the abolition of export duties for rough diamonds, which took place in September. This move has eliminated the privileged environment for the domestic market. The situation for diamond manufacturers worsened so that in the view of some stakeholders 2016 may turn out to be the last year for this industry in its present form. The diamond manufacturing industry needs a quality leap in performance, as government support measures will not be enough after the abolition of the export duty, Bain says in its report on the state of the diamond industry.
Russia produced 300,000 carats of polished diamonds in 2014 for the total value of $ 670-680 million. The country accounts for about 3% of the world market. Kristall, a diamond manufacturer from Smolensk accounts for 40% of all polished goods produced in the Russian Federation, while Diamonds ALROSA contributes 20% to the country’s total production. According to Bain’s survey, diamond manufacturing in the Russian Federation has dwindled by 7% since 2010, and the slump is mostly felt in the segment of large and medium-sized stones (12-13% per year). The share of small stones (under 0.3 carats) increased to 47% from 34% in 2010, making 20% in value terms. The main category of polished diamonds produced in Russia covers stones weighing 0.2-0.29 carats.
Over 90% of Russian polished diamonds are exported, which means that their product range fails to attract demand in the domestic jewelry market focused on low-budget goods (the average ticket price being 15,000 to 30,000 rubles). Usually, retail in Russia is supplied with imported melee-grade diamonds.
Globally, the diamond manufacturing sector has an operating margin of 0-3%. Russian diamond cutters work with minimal or negative profitability. Everyone survives in different ways:
- Diamonds ALROSA is a subsidiary of ALROSA, which makes it possible to save on the cost of rough;
- Smolensk-based Kristall is a state-owned company, which gives it a possibility to receive support from the state (for example, Gokhran bought RUB 3 billion worth of diamonds from Kristall in 2015);
- Companies belonging to international groups (as for instance, Ruiz Diamonds, which is part of Lev Leviev Group or SD Diamond, which is part of KGK Group) are financed by other businesses and use the global distribution network;
- Russia-based private companies establish joint ventures (like Sakha Diamonds and Eurostar Diamond) to have access to technologies and the international distribution system) or get vertically integrated into retail (EPL Diamond).
There are about 20 companies operating in Russia's diamond cutting segment, while the industry as a whole employs around 3,000 workers.
Key performance indicators of Russia-based diamond manufacturers outside Yakutia in 2015
Key performance indicators of diamond manufacturers in Yakutia in 2015
According to experts, due to the devalued ruble, Russia's cutting and polishing companies can compete with India, the world’s diamond manufacturing leader, in the segment of polished goods exceeding 0.3 carats, but only if the 6.5% export duty on rough diamonds is preserved. In September this year, this export duty was cancelled to comply with the terms of Russia's accession to the WTO, despite the vigorous attempts by diamond manufacturers, primarily Smolensk-based Kristall, to achieve the abolition of this obligation. The terms of trade practiced by ALROSA with its customers inside and outside Russia are now equal, which in the opinion of top managers of major Russian diamond cutting companies makes rough purchases non-remunerative. "Currently, the situation in the domestic market is sad. There is no reason to buy at prices that do not differ from export prices. Our company has suspended development plans and we have tightened our belts," stated the head of one of ALROSA’s customers based in Russia.
The government of Yakutia, where there are eight diamond cutting companies accounting for 30% to 35% of the total polished production in the Russian Federation, initiated another move asking to zero out the 18-percent VAT on the sale of rough to diamond cutters. According to Kristall, the VAT is no longer a problem, as it has been solved by ALROSA, which provides payment respites to its customers. The issue of VAT cancellation, which is mainly unpopular with the fiscal authorities, is being discussed along a number of other scenarios aimed at elaborating a strategy for the development of the diamond processing industry in the Russian Federation for the period up to 2030.
The difference in production costs between Russian and Indian diamond manufacturers is due to the high cost of personnel in Russia and more expensive financing because of high bank interest rates (7-9% in dollar terms in the Russian Federation and about 4% in India). Rough resale deals are an important component of revenues, but in Russia it takes 3-6 months to close such transactions, while in India it is a matter of a few days.
ALROSA and diamond manufacturers are negotiating preferences with the participation of the Ministry of Finance. The share of the Russian market in ALROSA’s sales is about 10%, but the miner’s position of a state-owned company and the main player in the Russian diamond market makes it one of those responsible for the future of Russian diamond manufacturing. In addition, the abolition of export duty on diamonds will bring ALROSA about 10-11 billion rubles a year, some of which may be used to subsidize the processing industry. ALROSA has prepared its proposals to support the diamond manufacturing sector. The first way is to provide 1.5 billion rubles (it is the sum spent by Russia’s diamond cutting companies for purchasing rough) through development institutions to subsidize the interest on loans for buying rough, financing technical re-equipment programs and eliminating cash shortages. Part of this money may go to cutting and polishing companies that are part of ALROSA (Diamonds ALROSA and Barnaul-based Kristall).
The second way is to offer diamond cutters 90-day installments for the payment of 40% of the contract value. Currently, the installment is 18% (which is the VAT). "In each case, everything will be considered on an individual basis. There are companies that really deserve such support, as they are our regular customers accounting for an albeit small but steady amount of purchased goods. These are not middlemen, which buy diamonds from us and sell them to someone else. In addition, not all of them ask for installments – those who need installments account for no more than 2-3% of our sales,” Rinat Gizatulin, Vice President of ALROSA commented.
That said, ALROSA is not ready to give its Russian customers price preferences (this is one of the proposals set forth by Kristall) or return to the practice of offering ‘selected’ lots of goods. "We have once been through this kind of practice and we have already sold goods at a discount to Russian manufacturers, but after a week we used to see them on the market somewhere in India, Singapore or Antwerp," Gizatulin said. Preferences are possible even within the normal course of business - some of the Russian customers of ALROSA say that the diamond miner offset the shock effect of an upsurge in prices by lowering the monthly limit of mandatory amount of rough to be bought under the contract during the September trading session to 50% from 70%. This measure involved the domestic market only, while the limit for overseas buyers remained at 70%.
In the opinion of Bain, to improve their efficiency Russian diamond cutters should focus on the diamond segment exceeding 0.3 carats, as the production cost of smaller diamonds remains here much higher than in India and has a limited potential to be reduced. After the abolition of the diamond export duty Russia’s manufacturers will not do without reducing production, commercial, managerial and administrative costs to the level of best practices in this country and comparable companies in India. It is necessary to develop their own distribution network or attract foreign partners, as well as increase sales to small and medium wholesale companies and to jewelry manufacturers in order to obtain a premium on the price compared to large wholesale. In other words, there is a need in expanding the efficiency enhancement practices, which are already used by some market players.
Sergey Bondarenko for Rough&Polished
