March 16 (Bloomberg) -- Philip Gwatidza sleeps in a cave at night and evades policemen by day as he scrabbles for diamonds in the gravel of eastern Zimbabwe.

Gwatidza, 30, is one of as many as 20,000 people who have been illegally hunting for gems with shovels as they fight to make a living in a country where seven out of 10 people are unemployed and annual inflation was 1,730 percent last month.

``Times are hard,'' said Gwatidza, clad in a plastic sheet to fend off rain, tattered pinstriped trousers and no shirt or shoes. ``Most of us are now unemployed. We need to get money for our parents and our brothers and sisters.''

The fight for gems is depriving Zimbabwe President Robert Mugabe's cash-strapped government of funds it needs to import fuel, power and food. Smugglers who buy the stones are also undermining the Kimberley Process agreement, signed by 45 nations, that requires certificates of origin for all gems to halt the illegal trade that has financed African wars.

The Marange diamond seam was disclosed in September by Nettlestead, England-based African Consolidated Resources Plc, which owned the property. The government's Zimbabwe Mining Development Corp. seized the 10-hectare (25-acre) site in December, citing pre-existing property rights. Andrew Cranswick, chief executive officer of African Consolidated, says his company may seek compensation.

After the announcement that diamonds had been found, thousands of people converged on the area.

``They came in droves, lifting diamonds on a scale never seen,'' Cranswick said from Harare, Zimbabwe's capital. ``Those stones have found their way into South Africa, the Congo, Sierra Leone, Israel and Lebanon.''

Smuggling Losses

Today the site is guarded by police officers who, thanks to rampant inflation, earn the equivalent of $5 a month. State-owned newspapers have reported that police have been digging for gems themselves and a senior government official was caught at Harare airport with diamonds in his possession.

Reserve Bank of Zimbabwe Governor Gideon Gono said Feb. 27 that smuggling costs Zimbabwe as much as $40 million a week.

The illegal mining has eased poverty in Marange. Diamonds have been exchanged for everything from satellite dishes to goats, said local resident Kizito Benhura.

``Our whole area has been transformed,'' Benhura said. ``This is empowerment like you've never seen.''

The illicit trade led Mugabe, 83, to declare last month that he may nationalize all diamond mines. As many as 27,000 illegal diamond and gold miners have been arrested, the state-run Herald newspaper reported.

Farm Seizures

Zimbabwe has the world's fastest-shrinking economy after a failed land redistribution program, in which white-owned farms were handed over to black subsistence farmers, devastated the country's agricultural production. Political unrest erupted March 11, when opposition leader Morgan Tsvangirai was beaten and arrested by police who broke up a prayer meeting in Harare.

Mining is now the country's main source of foreign exchange, accounting for almost half of exports in 2004, according to Johannesburg-based Standard Bank Group Ltd.

While the area around the Marange concession is being patrolled by police, security is lax.

Smugglers hide gems in car tires to get through road blocks, said Rina Kakore, 51, who lives near Marange. Her hands are calloused and two fingernails are missing as the result of searching for stones she says are heart-shaped and emit a green light when viewed from an angle.

Illicit Profit

``I can buy a bag of diamonds from the Marange diggers for as little as 200,000 Zimbabwe dollars ($713),'' a man who gave his name as Isaiah Jeche said in an interview in Harare. ``Those same stones will earn me about 20,000 rand ($2,700) from the Lebanese traders in Johannesburg.''

Zimbabwe has two official diamond mines. Murowa is run by Rio Tinto Plc and RioZim Ltd. River Ranch is owned by a closely held company of the same name.

Under the Kimberley agreement, named after the South African town that was the site of a 19th century diamond rush, gems must have documentation showing they were obtained legitimately. The European Commission, which is currently in charge of enforcing the accord, is reviewing the area's diamond trade, said Xavier Marchal, the European Union's ambassador to Zimbabwe.

On the 100-kilometer (62-mile) highway between Harare and the town of Mutorashanga, travelers are searched at five roadblocks.

``They even search through our hair to see if they can find gold dust,'' said Mavis Musarurwa, a housewife traveling to Harare. ``It's quite degrading, but many people are smuggling gold to South Africa.''

For now, the state's revenue needs are being given precedence over those who say they need to steal to survive.

``Times are very hard in Zimbabwe now and people are trying to make money by any means they can,'' said police Sergeant Taurayi Jokonya, who commands a roadblock on Harare's city limits. ``It costs the country a lot of money.''

To contact the reporter on this story: Brian Latham in Harare via the Johannesburg bureau on pmrichardson@bloomberg.net; Antony Sguazzin in Johannesburg asguazzin@bloomberg.netGodfrey Mutizwa in Johannesburg at gmutizwa@bloomberg.net

Last Updated: March 15, 2007 20:16 EDT