Free market and VAT

Rough and Polished

Diamond business, like any other, is subject to cyclicality. All of us could see this clearly quite recently – from 2008 to the current year, 2013. The intensive growth of the world’s economy and Russia’s in particular, provoked an outburst of trade in rough and polished diamonds in the mid-2000s.

The year 2008 witnessed the peak of madcap rise in prices for these precious stones. The subsequent plummeting downturn and recession, during which ALROSA experienced a hard-hitting economic shock, should have been an occasion for rethinking the current situation in the industry. But unfortunately, this did not happen and 2010-2011 were likewise rash in terms of rapid increase in rough prices. And even the past year, 2012, which laid the scene for another nose-dive in the market, failed to cause reflection. Now, at the very start of 2013, in all appearances, we are once again astride a macroeconomic sinusoid crawling upwards, and it is impossible not to draw attention to the problems that prevent Russian entrepreneurs from being efficient in the diamond business. Otherwise, another economic crisis will finally dismantle even those tenuous rudiments of diamond industry, which are observed in Russia today.

Throughout the lifetime of ALROSA as a mining company that has the right and ability to sell diamonds in the free market it took great pains to shape the domestic market for processing rough diamonds and manufacturing polished goods. Some were lucky and managed to establish a more or less successful business, while others were far less fortunate. However, in spite of ALROSA’s booming trade in rough, the domestic diamond manufacturing industry has not been able to become a revenue contributor to the state budget. The entire profit in this very specific business is generated by rough exports. The most important and real buyers remain to be trading and purchasing companies from Israel, Belgium and India. And if you face it, the existing Russian diamond cutting factories are either established by foreign nationals and companies or work for particular foreign investors. Only very few of them are trying to create something which would be their own and independent of the subjective will of speculators and which would solely be aimed at preferences of the free market and end consumers of jewelry, that is at ordinary people who buy jewelry at stores.

In my view, and this view is shared, I think, by a vast majority of entrepreneurs, the main reasons for the failure are rooted in domestic legislation – tax, custom and criminal law. Terrible bureaucracy rampant in Russia’s customs is already the talk of the town – goods clearance takes here two weeks or more, while in Belgium the same procedure takes one or two days. Just one example: the customs procedure for the import of rough diamonds to Dubai in the United Arab Emirates took me about an hour, during which an employee of the Arab Customs treated me to tea and chocolates. That is service! I say this without any irony. Will this ever be possible in Russia? The question appears rhetorical. The situation with the VAT payable on the value of rough diamonds also caused considerable debate within the expert community. The application of the value added tax where there is actually no added value, as it is raw material not yet processed, seems to be absurd in itself. However, the VAT is levied on rough sales spoiling nerves and wasting time and money of Russian diamantaires. And in most cases, the VAT is refunded from the budget after the export of rough or polished diamonds. That is, putting it in simple words, the diamond manufacturing industry advances money to the state for six or twelve months and gets its money back provided, of course, if everything is done fair enough to comply with the tax legislation. An abbreviated refunding procedure is reduced to one or two months. How much is gained by the state from this kind of economic cooperation is another (rhetorical) question. After all, this kind of VAT will not help you pay salaries to teachers and doctors, or pensions to the elderly and veterans. In this situation, the sale of diamonds abroad without VAT looks like rendering support to the foreign business class. Again, I say this without a trace of irony!

The most effective solution, contributing to improving the investment climate in the industry and thus stimulating economic growth, will be a drastic measure – abolition of the value added tax on sales of rough diamonds in the domestic market. It will give Russian companies a chance to buy more rough for their own use – both for manufacturing and subsequent sale. The latter point of this thesis is very important. We have to change our attitude to diamonds now viewed as some kind of sacred things. They are just an item of goods. Yes, they are precious goods, but still goods that can be bought and sold. For Russia, it is a vital need to have a market for free trade in rough diamonds, which will give an opportunity to develop the domestic diamond cutting industry as well. Indeed, the number of companies in this sector has not increased in recent years. While growth was registered only in economic indicators depending on the rising prices for rough diamonds and finished goods sold in international markets, the number of domestic diamond manufacturers remained the same and hardly changed since the early 1990s. Since we do not have a national credit system to finance the diamond business and rely mostly on personal or foreign investments and because there are no educational institutions for training personnel in the fields of diamond cutting, diamond trade and diamonds valuation, the only solution is to liberalize the market trading in rough and polished diamonds. The market will find the right solution unaided, and the country may finally get its own diamond market, where you can buy or sell any amount of rough or polished diamonds.

Take, for instance, Israel and Belgium, where there is a relatively small number of diamond cutting factories and a large number of trading companies carrying out exclusively commercial functions. The Russian market of rough and polished diamonds is to be similar in structure and function. If diamond mining remains the exclusive province of large state-owned corporations, the diamond trade should be regulated by the free market. Furthermore, licenses for rough export should be cancelled. One way or another, diamonds are exported from Russia, and therefore it is necessary to simplify the customs procedure to increase trade and hence customs payments to the budget.

The future belongs to those countries which are efficiently facing new challenges and threats and which are not afraid to change in line with the rapidly changing environment. The success of our diamond industry depends on how quickly and effectively the Russian government will respond to changing economic conditions. A balanced and circumspect policy should be aimed primarily at supporting small and medium-size businesses in the diamond industry. After all, it is impossible to make the market free by turning public just a single company, ALROSA.

Yegor Yegorov (OOO Infinity Diamonds)

Source Rough and Polished