The past few years have been difficult for the global diamond industry.
After a rapid recovery from the 2008 financial crisis, prices have been sliding since 2011. An index of rough diamonds by Polished Prices, a market data company, last month reached its lowest level since 2010.
Volumes haven't done much to compensate, with supply holding about steady for five straight years and industry revenues this year expected to be exactly the same as in 2013, at $79 billion, according to Anglo American Plc's De Beers unit.
Things may be about to get a lot more difficult. Almost 80 percent of the world's gem diamonds are cut and polished by a few thousand players in India who typically pay for their rocks upfront and sell on credit, according to Olya Linde, a partner at Bain & Co.
With the government of Prime Minister Narendra Modi pulling 500- and 1,000-rupee notes from circulation as part of his campaign against corruption, that link in the industry is about to get weaker.
Cash lubricates the Indian gem industry from top to bottom. PC Jeweller Ltd., a retail business, has been seeing only about 40 percent of the foot traffic it would expect since Modi's policy was announced last month, Chief Financial Officer Sanjeev Bhatia said on an investor call last month.
It's the effect on cutters and polishers that may have the most widespread repercussions. The segment has the narrowest margins in the diamond value chain, according to a report Monday by Bain, so Modi's demonetization drive is hurting the industry at its weakest point.
Things had already been looking harder for cutters and polishers, which have borne the brunt of the price declines and have only just finished building up inventory levels in anticipation of stronger demand.
Standard Chartered Plc announced in June that it was quitting its $2 billion diamond financing business to reduce exposure to a default-ridden industry, deepening a credit squeeze after the 2014 wind-up of the Antwerp Diamond Bank, KBC Group NV's specialist gem-finance arm.
For an example of what may happen as the withdrawal of currency plays out across the trade, look at Gemfields Plc. The world's biggest emerald producer last week postponed its December sale because the banknote drain left Indian buyers of the green stones short of cash.
A state-owned miner, Coal India Ltd., pulled an auction for similar reasons last month.
The effects of all this won't last forever. Gemfields will hold its delayed emerald auction in February and Alrosa PJSC, the biggest Russian miner, is phlegmatic: Demonetization-related turmoil will last three to five months and affect mainly cheaper diamonds sold to the Indian market, Chief Executive Officer Andrey Zharkov said on a Nov. 23 earnings call.
Still, India is the third-biggest consumer of gem diamonds, so a short-term drop in local demand risks rippling through the global trade at a time when the market is finely balanced.
Bain expects rough diamond output to increase sharply next year after stagnating for the best part of a decade, rising to around 150 million carats by 2019, before declining over the following 10 years. That would be fine if demand was equally robust, but right now it's still fragile -- and Modi's demonetization drive will only heighten volatility.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
((Corrects description of cutting and polishing industry in the fourth paragraph.))
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