In mid-March, Yury Trutnev, Deputy Prime Minister of the Russian Government and Presidential Plenipotentiary Envoy to the Far Eastern Federal District visited the Republic of Sakha (Yakutia) and gave instructions aimed at establishing a diamond bourse and developing the diamond cutting industry in its territory. This kind of instruction was also given to ALROSA, OAO. Simultaneously, it was mentioned that a high added value should be left in the territory of Russia and that certain preferences are to be given to companies taking part in this project.
There is no doubt that materials for this trip of the Deputy Prime Minister were prepared, but it should be said that it was done very poorly from the point of view of industry participants.
Let us try to understand the essence of what is going on, introducing specific explanations as we proceed, because this industry is rather closed and deeply professional and it does not always subject to general economic laws.
Russia is a major and important member of the world diamond market mainly operating through ALROSA, OAO (Yakutia) and PO Kristall, OAO (Smolensk). Diamond processing as well as diamond mining has more than a fifty-year history in this country. Both mining and processing operations use the most advanced technologies based on the latest scientific and technical achievements in Russia and abroad. Take, for example, such a notion as the ‘Russian Cut,’ the internationally renowned symbol of the highest quality of polished diamonds. This is our domestic technology developed by Kristall and used by generations of diamond cutters working at his factory. Demand for such goods is high the world over, although it susceptible to market fluctuations and economic downturns.
Taking into account this experience acquired by our industry not only at the level of production, but also at the level of the world market, it would have been sufficient to consult experts fr om ALROSA and Kristall to understand the origin of added value in diamond cutting or, simply stated, resulting fr om manufacturing polished diamonds. Polished diamonds are the only thing that can be made fr om rough diamonds, 50-55% of which turn to dust in the process. It would seem very simple to calculate the efficiency of this business. Take a rough diamond weighing 1 carat and worth $ 500 and use it to make polished diamonds totally weighing 0.45 carat (the yield ratio in our case is 45%). As a rule, you get stones weighing 0.35 carat and 0.10 carat worth $ 500 : 45% = $ 1,111 per carat. Add a "high added value" of, say, 20% and get $ 1,333 per carat. Fine. Now go to the market, but there you’ll face an abrupt twist. Your goods are not something urgently needed, since you will at once find more than a hundred of such gems offered for sale by online stores only. And you will have to take into account that they are sold maximum at $ 1,200 per carat and even with a grace period of 90 days. Dog-tired of marketing, you will have to sell your goods for $ 1,150 per carat and think hard how to cover the costs. These are the realities of the market.
Of course, if we turn to the pattern of the diamond pipeline outlined by Chaim Even Zohar, a top industry analyst, we shall see an added value of 15-18% at the processing stage and its further growth already in the jewelry segment. Let us refrain from analyzing the jewelry segment of the diamond business, as it is the subject for a separate and long talk.
The above 15-18% is an ideal situation. Over the past two years, speculation in the diamond market has reduced this number to zero and even to minus values. This is a global problem for the entire diamond industry, which caused shutdowns of many factories.
Now about the costs.
The cost of manufacturing polished diamonds in Russia is as follows:
In Smolensk, it is about U.S. $ 80 per carat.
In Moscow, it is about U.S. $ 150 per carat.
In Yakutia, it is about U.S. $ 180 per carat.
It should be said that these figures are related to one’s own production, not to tolling. The difference between these types of processing is significant, since the tolling option does not imply credit costs and VAT. Generally speaking, you can certainly manufacture polished diamonds in Barnaul or Orel paying $ 40 per carat, but then, having added the cost of financing, you will get the figures given above.
There are three main types of costs in diamond manufacturing: personnel, credit and amortization of equipment. Even if you remove the amortization, personnel and credit costs will eat up 98%. To get qualified personnel you will have to train it. The vocational training system in this industry here collapsed in the early 1990s. Licensed personnel training, including specialists with higher education, can be offered only in one place, which is the Training Center of Smolensk-based Kristall.
Crediting terms in Russia are well known to everyone. Here it is worth recalling the speech made by the Governor of the Kaluga Region at the State Council in December 2013, who said that the added value in the manufacturing sector should be not less than 30% under the current financial and crediting system in the Russian Federation, which is unrealistic, as it used to be around 15% around the world. This prevents the development of all other industries, except the primary industries. The latter are cashing in on this situation, while processing segments are decaying. The same picture is in the domestic diamond processing. ALROSA posts billions in profits, while diamond manufacturing is dying. Russian polished production fell threefold only in the last five years (according to the Russian Diamond Manufacturers Association). In fact, there are only Kristall of Smolensk and ALROSA’s own manufacturing unit left.
Why is this happening? Because such is the situation in this field in the world. Eighty percent of diamond manufacturing is concentrated in India, where government support for this industry is most powerful helping to aggressively edge out competitors. Rough diamonds are distributed within the same cartel system based not on supply, demand and prices dependent on the value of polished diamonds, but on an artificial shortage of customers. The world over, there are only about 150 direct customers of mining companies and more than 5,000 would-be clients willing to take their place. This struggle for a place under the sun, eagerly encouraged by resource companies, brings about rampant speculation driving rough prices to indecent values and turning polished diamonds cheaper than rough.
Having analyzed all this, it's worth asking: Who is willing to play by these rules?
At whose expense will be the preferences? At the expense of ALROSA? Its shareholders are unlikely to approve it. Do not forget that the company is public and its stock is traded. And one more thing: when there is a difference in prices for rough, the temptation to resale it outweighs all arguments to invest in production. Especially because we know how many laps of bureaucratic hell there is to go through for an investor.
Let’s speak about the diamond exchange.
What is a modern diamond exchange? First of all, this is mainly an environment for diamond trade in a particular jurisdiction. The associated terms and conditions include the free movement of goods across the border and the customs functioning in both ways and complying with the accepted international regulations, as well as the proper logistics, tax regime, availability of office space and security system.
In the Russian market, its players are fighting for free movement of goods for the second decade running. There is no program approved by the government, which means there are no rules. Rank-and-file officials cannot take on this responsibility, because law-enforcement authorities may accuse them of corruption. It’s a vicious circle. Customs and state control are another obstacle. In India, Antwerp, Hong Kong, or Dubai this procedure takes from one to three hours. In our case it is from one to three months. What else is there to say?
A few words about logistics and availability of office space. You will face no problems with this in Moscow or Smolensk. However, you will have to put quite an effort to develop this in Yakutia. And prices there will be no lower compared to Moscow.
Finally, the tax regime. The VAT levied on diamonds sold inside Russia and the complex system of its reimbursement have no analogues in the world. Nowhere else, except South Africa and Russia, there is such a thing as the VAT, but in South Africa it takes one month to get it reimbursed, whereas in Russia you will be waiting from 6 months to infinity, depending on the province.
And bringing these ‘homely reflections’ to a close: Of course, one may think that it is sheer criticism and lack of patriotism. But this is the real situation. This is the truth. We can burry our heads in the sand like an ostrich not to see what’s going on around, but it will not help.
The eternal question: What is to be done?
We must urgently adopt a program for diamond manufacturing in Russia. Preferences at the expense of ALROSA are hardly worth pursuing. But there is a mechanism of export duty. Now it is 6.5%. Having created a regulatory mechanism, as in oil exports, Russian manufacturers will receive the difference in price equal to this export duty. The only thing we need is to require from ALROSA a transparent pricing mechanism taking into account this export duty, which then should be preserved by all means.
Russia has a unique agency, which is Gokhran of Russia purchasing and selling precious stones and precious metals. Expanding its powers to have an opportunity to form a portrait of its clientele (investors), Gokhran will be able to provide a mechanism for diamond sales in the domestic market. Here, the Government needs only to determine the amount of annual purchases of rough from producers. For example, South Africa has it at 15%.
Further, we should simplify the registration of transactions related to diamond exports and diamond imports bringing the procedure to a maximum of 5 days. It does not require any legislative initiatives, it requires only to change bylaws.
In short, if all this is not done, then we shall not be able to create anything new and we shall lose what is left.
Andrey Petrov for Rough&Polished
