Russia’s leading diamond cutter, Smolensk Kristall, is being forced to shift its manufacturing business to China by a combination of supply and price troubles that industry sources blame on the link between De Beers and Alrosa, Russia’s diamond-mining company.

Maxim Shkadov, deputy general director of Smolensk Kristall, told The Russia Journal that he will soon open a new diamond works with an unnamed Chinese partner in Guangzhou, a southern Chinese province. The works will be supervised by the Hong Kong office of Smolensk Kristall. The Chinese partner already operates four diamond-cutting plants. Small Russian stones of less than 0.15 carats are to be supplied for Chinese cutters to cut and polish on a tolling contract that will return the stones to Smolensk for sale. Tolling avoids direct export of the stones from Russia, on which the Russian government levies a 6.5 percent export tax.

About $10 million worth of rough diamonds will be supplied to Guangzhou in the first year of operations, Shkadov said. "Whether more rough will be provided in the future will depend on how effectively this factory will work, whether we will be satisfied with the quality and whether the mechanism [for transfer of rough on tolling contract] will work appropriately," he clarified.

He said that sale of the polished stones "will be aimed at the Chinese market, where we expect significant growth in the near future."

During the brief period of expansion of the Shanghai diamond industry in the mid-1990s, efforts were made to open a direct Russian supply channel in the framework of an intergovernmental agreement signed by Moscow and Beijing officials. State-stockpiled diamonds, it was anticipated, would be supplied to the Shanghai cutters, but the plans came to naught.

According to Ararat Evoyan, president of the Russian Association of Diamond Manufacturers, Kristall’s project in China is a breakthrough. "The situation in China was first studied by a Russian delegation back in 1997, when Russian diamantaires first got acquainted with the state of the polishing industry in Hong Kong and Shanghai and learned what the industry there was like, what the conditions, salaries, etc., were," he said. "We understood that the conditions there and the quality of production were good. But there was never any direct trade in rough diamonds. At present, only Kristall sells some diamonds in Hong Kong."

A similar, though more recent, attempt by an Indian parastate group to arrange a small $4 million purchase of Russian rough from the state-stockpile agency, Gokhran, also failed to be implemented. Negotiations to revive that channel are now underway in Moscow. But, to date, there is no tolling contract for Russian diamond supplies to an Indian or Indian-Russian plant in the Mumbai region. Instead, there are some Indian efforts to set up polishing ventures in the Russian Far East.

"By providing small-size diamonds on a tolling basis," Evoyan told The Russia Journal, "Kristall will be in a position not to pay the 6.5 percent export duty on rough. (There is no export duty on polished.) The process of getting rough diamonds out of the country on a tolling basis is not more complicated than exports of rough, and so I think that tolling of small-size diamonds to China will be cost-efficient. $10 million per year is actually not a small volume, because it’s small-sized diamonds, which are profitable for cutting in India and China."

Smolensk Kristall, which is state-owned, was recently reconfirmed by De Beers as the only Russian sightholder able to buy rough from De Beers’ Diamond Trading Co. Smolensk Kristall also has an annual contract for supplies of rough from Alrosa to meet a production target of about one-quarter of a billion dollars in value per annum. But, according to a leading Russian diamond-industry source, mismanagement inside Alrosa is artificially raising the price of rough available to Russian cutters, forcing them to move abroad. This, in turn, benefits a new cutting and polishing venture Alrosa intends to operate in Moscow, Almazny Mir.

"The attempt to move production to China is a result of the situation with supplies from Alrosa and the situation with [Alrosa’s] prices," the source told The Russia Journal. "In a situation in which Alrosa is increasing prices for rough, some companies in Russia are being forced to move a number of their operations to countries like India or China.

"I think that even polishing diamonds on a tolling basis in China will not provide the necessary profit, because the prices for diamonds [set by Alrosa] are too high, even though tolling allows not paying the 6.5 percent export duties."

Evoyan too accuses Alrosa of exploiting its ties to De Beers, to which it supplies about $1 billion of its annual $1.6 billion production per year. "The situation with Alrosa’s prices is not normal. This is a result of actions by De Beers, which have decreased the number of sightholders. This led to some agitated demand for diamonds and growth of prices," he said.

"However, the increased prices didn’t correspond to the prices for polished diamonds, which remained the same. Now, the prices for rough have decreased already [outside Russia], but Alrosa is always lagging behind, and their prices have not decreased and are too high at the moment."