Rapaport Magazine

Russia

By Anastasia Serdyukova
Rough Prices, Taxes Strain Business

Sales of polished diamonds slowed in July due both to seasonal reasons because many companies send their employees on holiday and the general stagnation at the market that is caused by high rough prices and slow sales of polished. Russian manufacturers say that high prices combined with the 18 percent value-added tax (VAT) decreases profits to the point where some are even considering leaving the business.
   Companies say that the increase of rough prices over spring’s prices by ALROSA, the country’s major miner, and De Beers was the most damaging event to current activity. “The situation at the market is bad. If mining companies don’t cut the prices, the situation will get even worse,” said Rajesh Gandhi, director general of Choron Diamond. “The combination of high rough prices and the value-added tax brings down the profit margin almost to zero,” said Marina Yablokova from Arkhangelsk-based manufacturer Zvyozdochka.
   Market participants report that companies are buying rough with delayed payment, which was rarely the case previously. In addition, reselling rough that comes in a box, but is not used by a manufacturer, has also become very difficult, if not impossible. “The risks of dealing with the rough have become very high,” said Nikolay Afanasiev, the head of marketing for Kristall Smolensk. Companies add that the shortage of financing contributes to the overall strain.

Killer VAT
   Apart from the problems that are generic to the international diamond industry, Russian manufacturers experience the additional pressure of the VAT of 18 percent, introduced in 2008, that they have to pay when buying rough. Russian manufacturers sell most of their product abroad and the tax is paid at the time of sale, then reimbursed by the government several months later. Although most companies have established financial systems to cover the tax expenses, usually through special agreements with banks, the process freezes available funds and adds another 3 percent to 4 percent to their overall costs, according to Ararat Evoyan, vice president of the Russian Diamond Manufacturers Association.
   Turning to the domestic market to sell their products — and avoid the tax altogether — is not an option for the companies because the domestic market is too small and domestic jewelry companies prefer small gems, which are unprofitable to produce in the country due to taxes and high labor costs. Jewelry makers increasingly prefer buying rough from India and China because it is cheaper. “The pressure from foreign companies, especially the Indian ones, is very strong,” said Yablokova.
   The increase of the dollar against the ruble also adds to current industry problems. “People don’t want to buy now because they are waiting for the dollar to fall,” said Kalpesh Shah of Shrea Core.
   What helps smaller manufacturing companies survive tough times are their established long-term contracts with foreign companies and the fact that they can use polished in the production of their own jewelry. Yablokova said that while the supply contracts have declined to 200 stones to 300 stones a contract from as many as 2,000 stones two to three years ago, the volumes allow them to keep up the production. The company uses what is not sold in the production of its own jewelry, expanding this department over the years.
   If the situation continues, more companies will consider leaving the business, according to market participants. “The past two years were very tough and people are getting tired, so they are considering investing somewhere else,” said Gandhi.

Cautious About India
   Russian manufacturers are watching the slowing in the growth rate of the Indian market with caution. The growth rate does impact the global trade of diamonds, which Russia is part of, said Afanasiev. But the biggest short-term effect is the shortage of financing because banks worry about the overall situation in the industry. On the other hand, the current turmoil may wash out those Indian companies that were engaging in speculation in the market, which could lead to making the overall market healthier. “It will help other companies increase their competitive advantage in the long run, but the temporary side effect is that many have to suffer,” said Afanasiev.
   Inside Russia, the attitude toward Indian companies is mixed. On the one hand, Indian companies have been investing in several Russian manufacturers in Moscow and in Yakutia, providing them with equipment and finances. “They come to the Russian market for the access to rough,” said Evoyan. “Usually the ones who failed to come to agreement with ALROSA are using Russian companies as a back door to get to rough.”

Jewelry Sales Slow
   Jewelry sales in July rose slightly compared to May and June. Sales are good in the high-end sector because people want to buy something new before they go on holidays, according to Svetlana Rakhmanina from Rifesta.

Article from the Rapaport Magazine - August 2013. To subscribe click here.

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