Is India's Diamond Biz Losing Its Luster?

The country is still a huge processing center for the stones but faces challenges from Chinese competition and slower growth in the U.S.

India is perhaps best known for its dynamic outsourcing sector, well-regarded software development, and emerging conglomerates such as Tata, Reliance, and Birla. Yet India has also long been the world's biggest center for processing uncut diamonds imported from African mines, primarily in South Africa, Botswana, Congo, and Angola.

It's a $12 billion industry, and diamond polishing and processing factories in Gujarat and Maharashtra are big employers. India's diamond industry employs about 3 million in all. And Indian Prime Minister Manmohan Singh's government hopes to keep it that way. In early May, India's Finance Minister Palaniappan Chidambaram announced that polished diamond imports would be duty-free, a relief from the previous 3% levies.

It was an important victory for Indian diamond merchants, who face a multitude of challenges these days in this ultra-competitive market. Local players have long argued that the tax relief is justified if the domestic industry, already a leader in diamond processing, is to be given a chance to develop into a major trading hub and eclipse rivals in China and Thailand. "We can now import diamonds of all sizes, and show buyers both the diamonds and the jewelry from any of our global offices," says Sanjay Kothari, head of India's Gem & Jewelry Export Promotion Council.

Lower Labor Costs

That's important, since India's diamond trade needs to diversify. India has been processing smaller and lower-quality diamonds compared to the larger ones polished and cut in other countries. That said, the industry still has a big cost advantage over other diamond processing centers. (see, 5/24/07, "Are the Diamonds Forever?").

India's average $10-per-carat labor cost for cutting and polishing is much lower than the rest of the world. For instance, the same figure in China is $17 a carat, while it is $100 in Tel Aviv and $150 in Belgium. As a result, even as India accounts for 85% of the diamond processing business by volume, its share measured by value of the product is 57%.

Over the years, India has been going up the value chain by making gold and diamond-encrusted jewelry for export. But while it could only use the smaller diamonds it processes, it often left a gap for larger ones to be filled in overseas, as importing polished diamonds was expensive given the import duties. Even so, in fiscal 2007, India imported $2 billion worth of cut and polished diamonds.

Signs of a U.S. Slowdown

Today, the U.S. accounts for 32% of India's $17 billion in exports of cut and polished diamonds and jewelry. However, the U.S. market is showing signs of a pullback, given the slower economic growth this year. India's total diamond sales declined to $11 billion in the 2006 fiscal year from $12 billion in the 2005 fiscal year. "The economic slowdown in the U.S. is affecting Indian exports," says Raghav Narsalay, chief economist at consulting firm Economic Law Practice.

Kunal Shah of KBS Designs, a five-year-old diamond export house that sells 90% of its jewelry in the U.S., says sales have suffered as more budget-conscious U.S. consumers shift to smaller purchases. "It is a challenge to make people in Middle America buy more," says Shah. "Even for gifts, we are competing with the iPods."

Another challenge is that India's rapid economic advancement may mean the end of preferential treatment of its diamond exports. Five years ago, India was still considered a developing country and thus the U.S. waived a 6.5% import duty levied on jewelry imports. "The duty benefits give us enormous leverage in a market where the trend is moving away from jewelry," says Vasant Mehta, senior partner at V Rameshchandra & Co, a diamond export house.

Smaller Piece of the Pie

If there is no waiver, a major beneficiary will be China, which is in a position to benefit from India's export duty burden. China has been processing larger diamonds for jewelry making and importing rough diamonds worth about $1 billion a year.

Also, diamond mining countries in Africa are making efforts to process diamonds locally. This will affect India's share in the global sweepstakes, predicts a survey by consulting firm KPMG. By 2015, India's share of the processing pie is expected to shrink to 49% from 57% now, with China at 21.3% (see, 12/8/06, "The Other Diamond Story").

On top of that, South Africa is weighing a move to slap duties on the export of rough diamonds that would push up the material costs for Indian players. As a result, Indian diamond concerns are exploring opportunities in newer markets, including its own expanding middle class that is enjoying more spending power these days.

Already, big retail houses like Wal-Mart (WMT) and India's own Future group have been talking about launching jewelry counters to meet local demand. One thing's for sure: India's diamond industry needs to cast around for new sources of growth.

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