We should change approach to diamond processing industry entirely to develop diamond cutting business – Kristall CEO

Governmental support and recovery of the market enabled the Russian largest diamond producer – Smolensk-based Kristall – to get back to pre-depression levels of sales. However further development of the industry also requires governmental support – primarily involving alteration of legal framework. Chief Executive Officer of Kristall spoke to Interfax reporter on the problems faced by Russian diamond cutting industry and possible solutions.

- Many experts claim that demand and prices at the diamond market have already recovered to pre-crisis levels. Has Kristall experienced these developments? What are the results of your activities in the first half of 2010?

- I suppose it is incorrect to correlate figures with the same posted during the crisis year, as we used to get specific figures. This year, in terms of profitability, we can see the positive trend. However we expect decrease in the rate of profitability from September, as rough prices have gone up. We suppose the positive trend observed in the first half of 2010 is unlikely to remain in force, however we will still be profitable – and the matter is to what extent. Following the results of the first half Kristall has got net profit worth 150M rubles.

- And what revenue have you got?

- About 5 billion rubles.

- As far as I remember, at the beginning of 2010 you were projecting such figures following the results of 2010 year at best?

- We made our forecast taking into consideration the current market environment at that time, which was instable. Now I suppose our revenue for the total year will reach 10 – 11 billion rubles. However we will see how the market behaves.
But in general, we can say that Kristall managed to position itself successfully and correctly orient itself at the market in 2008-2009. At the end of 2008 ALROSA withdrawn from the market and actually left us without a source of rough diamonds. We had to procure rough diamonds at external market and buy it from Gokhran. Gokhran as an instrument of governmental support used to buy a part of finished goods from Kristall and we did not withdraw from the market. As soon as ALROSA returned to the market we proceeded with conducting rough supplies from ALROSA. And the market has obviously become active this year. We have not seen such good figures for a long time.

- You managed to get to pre-recession levels as well?

- We showed even better results. Pre-crisis period was characterized with incredible level of prices for rough diamonds therefore our profitability was not so high. A diamond cutting enterprise may get the best figures amid either calm or increasing market. Meanwhile when rough speculations are on the way we cannot speak about profitability in diamond processing sector. In that case all market players start tuning in accordance with current market trends – cutting enterprises also shift to selling part of rough diamonds they possess. 

- They do resell rough diamonds purchased?

- Yes. They do resell parts of rough, not profitable in terms of processing. In principle, this is usual technological operation: of the total amount of rough diamonds purchased you select stones which are suitable to produce polished diamonds which will be actual and popular at the market. The remaining stock is formed to lots which are then subject to resale at the market. But in general this happens due to inhomogeneity of rough diamonds bought. Diamonds are not standardized stock goods, as rough diamonds are very different, and stones contained in box acquired by a company may differ much.
A diamond cutting factory operates in terms of profitability and efficiency. Rough diamonds which are not considered viable to process are separated for resale. Should a stone cannot be sold it remains lying and waiting in the wings. It may occur that prices go up and the stone becomes profitable. Should the prices remain stable there still are some options including mixing gems with those of highest profitability to process them in the aggregate as a box of medium profitability.

Practically this type of business operates in the same manner all over the world. However our legislation does not allow us to work in such a manner.

- Does legislation restrict you anyhow?

- There is quota which serves as a constraining factor. A cutting enterprise cannot either export or process abroad over 15% of rough stock bought from a diamond miner. The quota was introduced long ago, when code of conduct at the market was forming. But now the situation has changed. We are approaching to open market and integrated customs territory is emerging, Single customs union is created. More over, we plan to join the WTO. All that speaks in favor of the fact that we must be ready to competitive market conditions. And we are ready and we operate at this market, and I can say we are successful. However there are some non-market factors which prevent us from working in this environment.
At present time development of diamond cutting in Russia goes from and is dependent on the source of rough diamonds, namely distribution policy of ALROSA. At present ALROSA declares that all clients will get equal terms notwithstanding their nationality. And this position is correct. However de facto existence of such regulatory framework does put Russian companies to position not equal to that of other companies. Under such conditions diamond processing will not develop in Russia, unfortunately.
 
- What other similar problems, apart from quota, exist? 

- First and foremost, there are problems with VAT and VAT refund. 18% of the amount of each rough purchase are subject to exemption from the turnover within nine to twelve months. ALROSA supports Russian clients granting them a respite. But this is a matter of temporary arrangements between companies, while clear and comprehensive system should be implemented. ALROSA is not the governor of VAT turnover as this is the aim of legal framework, Russian legislation. Budget crediting is dangerous for a diamond cutting enterprise. Nobody would ever grant a loan secured by VAT refund.
Obviously none of entrepreneurs will work in such conditions. You can look at the system of cutting business which has appeared over the latest 20 years and look at those new private companies which were founded within this period. Majority of such enterprises represent structures of dealers who got access to cheap rough stock through these structures (previously rough diamonds were sold to Russian cutters at cheaper rates compared to export prices - IF).
Therefore it is clear that the quota was introduced in order to avoid resale of rough diamonds. But this restriction became inefficient as soon as prices were adjusted and distribution became transparent. Therefore, in order to provide conditions for diamond processing we shall entirely reconsider our approach to this industry. In this terms we are far behind the market – it is extremely difficult to fight with India and China.

- What has it to do with India and China? Russian polished diamonds occupy quite another niche.

- Russian polished diamonds are made of Russian rough stock, while the price for rough diamonds is determined on the basis of market environment. And the cost of polishing a carat of rough is one of the factors of price fluctuations at the market.
Anyway, we are not able to draw workforce in any region of Russia to cut diamonds for an average salary of 5,000 – 6,000 rubles per month. At the same time, Indian and Chinese cutters do work for such money. Here, in Russia such salary is unreal. Consequently, should the cost of processing a carat in India amount to $17-20, this will mean over $50 in Russia. The cheapest diamond processing activities in Russia are available in Smolensk while the same job is twice as expensive in Moscow or Yakutia.
And again it is clear that both Moscow and Yakutia implicate other working conditions where cheap diamond processing is unattainable.
Yes, it’s true that Russia occupies a definite niche in diamond processing which refers to expensive and high end goods. But China and India forge ahead, they strive to position themselves at all niches of the market. And should we fold our hands – we will throw in lot with Israeli diamond cutting which has practically vanished. We do not sit on our hands and are in progress constantly. So far competitors are unlikely to catch up to us in technological aspects. But what we need is competitive market environment in order to avoid being driven out of the market. The risk of resale of rough diamonds abroad conducted by some companies should not disturb normal operation of Russian cutting enterprises. This should be flunk out at the level of ALROSA’s distribution policy: the diamond miner forms client base ad should bear in mind those involved in real production and those engaged in profiteering. 

- Do quotas discourage you in terms of sales of unprofitable rough stock?

- Quota and customs procedures do actually immobilize us in utilizing cheap processing markets. We cannot be engaged in diamond processing on a give-and-take basis in Armenia, Ukraine, and Belarus where enterprises of the former Soviet system incorporated by Kristall are located. WE are willing to do that but cannot proceed due to the quota. And consequently we get dilemma emerged. For example, the cost of processing of certain group of rough amounts to $45 per carat in Russia, while the same work costs $25 per carat in the Ukraine. Ukraine has its production smoothly running right for this type of stock. It would be effective by all means, but the procedure of assignment of quotas ad transfer of rough and polished diamonds over the border would evener the effect.
The same thing is relevant to Armenia. It would be possible to make China and India work for us but existing system does not allow us to arrange this.

- Do you discuss this problem with the Finance Ministry? Are you awaiting assistance and facilitation?

- The issue does not refer to actions by Finance Ministry the latter not being the lawmaking body. Finance Ministry supports our initiatives and has done a lot for us.

Except for Finance Ministry the whole cutting industry would die during the global crisis. But this issue should be tackled comprehensively. Association of diamond manufacturers works on this issue and promotes corresponding initiatives. But not all comes out; anyway we will keep on working on it. Yakut Government has also done and still doing a lot for that end.
We get support at Finance Ministry concerning VAT issue, they assist us as possible. But they are not able to settle out all issues. Again, should the order of VAT charging be altered for the industry – oil & gas industry, producers of goods and medicines might request implementation of the same measures for their spheres and a small matter that it would be another market and another approach. That is why VAT issue is very complicated.

- And what’s with quotas?

- Concerning quotas – I believe the issue will be solved. But this moves very slowly. The latest decisions taken stipulated a term of one more year for bringing the legal framework to conformity with newly formed customs union. Within this period all the matters must be settled. Such union would help us very much.

- As of the current moment, what do the parties tend to lean towards? 

- Quotas will be abolished. And customs duties are likely to remain the same as are applied in Russia at present time. Russia is the major player at rough and polished market.

- Concerning the relationship between Kristall and ALROSA. Do your new agreements stipulate prices different from those with foreign companies?

- The exact price is not stipulated in agreement since price fluctuates depending on market conditions. As far as we know, the first long-term agreements of ALROSA with 15 Belgian companies provided for the fixed price but now the company has got off this condition. The price is floating and is defined in correspondence with current market environment. The volumes of rough stock are defined separately for each of the counteragents, on the basis of ALROSA’s possibilities.
At present time ALROSA actually faces rough deficit because of large sales to Gokhran due to the crisis, while the market has jumped significantly.
Apparently they expanded export share on long-term contracts concluded while the share of rough stock destines for domestic market was reduced. We can ascertain this fact. But basically this deficit might be reimbursed by means of using Gokhran stocks.

- By means of sale of rough stock which was bought from ALROSA?

- Yes. ALROSA now claims that it cannot provide all its clients with rough diamonds and suggests that they were working with Gokhran. Our enterprise faced the same story. In accordance with the renewed long-term agreement we have the volume of supplies reduced in comparison with the previous corresponding period. But given Gokhran’s rough stock supplies shall be balanced.
Nowadays we face such interim period; the crisis taught us a lot; a three-year post-crisis period of acting arrangements will pass away and we will look out over new upsurge in relationship with the diamond mining company.

- Have sales of rough stock been agreed on the level of Finance Ministry?

- Yes, they have been agreed. This year we expect adoption of decree on sale of additional stock from Gokhran. I suppose the decision on distribution of Gokhran’s stock will be taken next year. It is difficult to make plans for three years – we should pursue very cautious policy and monitor the market with scrutiny because having sold large quantity one may cause meltdown of the market.

- How many rough diamonds does Kristall itself intend to buy at Gokhran?

- We plan to purchase a lot of stock. We used to declare the volumes since the beginning of the year, however the exact volumes will be confirmed after adoption of the decree. It is too early to speculate on this issue. However Gokhran operates on domestic market where nowadays quite few active players stay.

- And will you sell polished diamonds to Gokhran? The market seems to have recovered; even ALROSA does not sell goods to Gokhran anymore.

- Initially we adopted program of sales to Gokhran for the current year, the same as ALROSA had. As for ALROSA – they are likely to adjust their program, they are not going to sell rough, facing apparent deficit. But we do implement our program. On average we sell 70% of polished diamonds at the market, 30% being sold to Gokhran. 

- Are prices offered by Gokhran above or below the corresponding prices at the market?

- Gokhran buys good at current market prices. Certainly some fluctuations take place but they are adjusted within the year. Gokhran cannot fix price for the whole year and there usually are discussions of price per each period. I can exactly assure that Gokhran accumulates stock which can be consequently sold at quite good prices with profit.

- Has the issue of the increase of authorized capital of Kristall been already solved?

- Yes. The state budget act has been adopted, where this regulation is stipulated. We are now addressing this issue and this is our main task till the end of the year.

- The budget stipulates merely the fact of increase of authorized capital for 4 billion rubles wile the scheme is not specified. Has it been agreed upon?

- Yes, it has been agreed and is now being worked off. The above amount is subject to deposit by means of gems located in Gokhran. The proportion will be equal – 50:50 – rough and polished diamonds worth 2 billion rubles each type of goods. We can sell polished diamonds and process rough diamonds to sell finished stock. 
Therefore the enterprise will increase own working capital. Rosimuschestvo (Federal Property Management Agency) will proceed with additional issue while we will undertake procedures pertaining to transfer of property injected to authorized capital. This is merely juridical work being now conducted and completed in time.