China's Communist party, which now embraces the concept of persona wealth, is striving to develop its diamond industry. Where once trade in precious metals and stones was highly regulated by ; state ill disposed to recognising a useful market value in vanity, commodities such a diamonds are now regarded as mainstream tradable products.
But China has come late to establishing the necessary institutional underpinnings of this business. The Shanghai Diamond Exchange (SDE), the first of its kind in China, was only set up in October last year Planners had been mulling over a diamond exchange for five years before the Stan Council gave Shanghai the' green light it March 2000.
The exchange is a Sino-foreign joint venture, something that the organisers believe will encourage further foreign participation Officials hope the exchange will help to localise the important wholesale and retail aspects of the business.
Shanghai's leading position
Shanghai was an obvious choice to locate the exchange. The city, prosperous in its own right, is easily reached from an increasingly wealthy hinterland. It is the largest diamond market in Mainland China and is also leader in other commodities, such as per. fume and coffee. It has an international presence to rival other great diamond centres such as Tel Aviv, Mumbai and Antwerp. In other words, it is in an excellent position to serve key domestic and international market1 for high-value prestige products like precious stones. Accordingly, Shanghai gets no only the SDE, but also the two diamond processing centres of Lujiazui (Pudong) and Longhua (Xujiahui). A gold exchange is due to open in Pudong in the next six months.
On an alternative reckoning, however, the localisation of China's diamond business in Shanghai represents a lost opportunity for other cities. Guangzhou, for example, is close to the great regional diamond centre, Hong Kong, and to the ready markets of ease and south-east Asia. Elsewhere, the choice of a lower-tier city along the east coast would have been more visionary – for example, an international spotlight on diamonds would have been welcome attention for diamond-producing provinces such as Shandong, Liaoning or Hunan. More interesting still might have been Wuzhou, home to China's man-made diamond industry and an established national gemstone centre in the process of building a Yn50m-70m ?gemstone city.? Impoverished Guangxi, where Wuzhou lies close to the border with rich Guangdong, could certainly have done with the business.
High import tariffs
In the final analysis, China's diamond industry may need Shanghai's political muscle. High tariffs on luxury goods are stifling interest in the sector, and in the SDE. Stones imported into China, turned around on the SDE and exported are duty free; but all sales into the domestic market, which would otherwise be the main draw for investors, incur tariffs and taxes totalling around 34 percent. Shanghai needs to lobby hard for equal tax treatment with its overseas rivals if it is not to become the lame duck of the world's diamond cities. The SDE is already struggling to expand its membership beyond the 40 or so signed up towards the end of last year.
The tax authorities, however, are not yet ready to bring down tariffs and taxes. They know that a vibrant industry depends on shifting the tax burden from the import to the retail level. However, they simply don't have the resources to cope with so many retail out-lets in such a big country, which would make it relatively easy for retailers to avoid paying tax. However, Mr. Nelson Wu, director of De Beers' Diamond Information Centre in Shanghai, believes a change in the tax system would inevitably follow China's membership of the World Trade Organisation, although he recognises that the government is unlikely to make it a priority.
In any event, the tax authorities could point to an industry that has been doing relatively well in recent years. Even under the punishing tax regime, demand for diamonds has been growing at 30-40 percent a year in China. In 1986, when De Beers started test marketing diamonds with television advertising and other promotions, the market was worth almost nothing. Today, it is probably the seventh or eight biggest market in the world. There is no official data because of the difficulty in getting information from the many small, private retailers. However, the latest national survey estimated diamond sales to be worth US$732m in 2000, and Wi believes this underestimates the true size o the market.
The Shanghai government certainly realises the potential importance of the diamond industry. The city has a long history of diamond trading and it has aspirations to become the world's biggest wholesaling and manufacturing market. In the first half of the 20th century, foreign businessmen who helped to build Shanghai also brought with them a diamond culture. The onset of the second world war brought in many Jewish refugees who carried their wealth in the form of gold and diamonds. This helped to develop an appreciation of diamonds among the local population and the establishment of a cutting, polishing and manufacturing industry.
Rekindling foreign interest
Today, foreign interest would certainly be rekindled if taxes were relaxed. Shanghai is desperate to attract more foreign investment to localise activities and bring in expertise. While diamond ownership levels remain far below those of the US, Japan and India, the market is expanding fast as urban incomes rise. However, one downside for the industry in a country in transition to a market economy is the growing number of other things that consumers can now spend their money on – including housing, cars and private education for their children.
Diamonds account for between half and one-third of all jewellery sales in China. Diamond jewellery has become synonymous
with weddings in China; there is no tradition of buying engagement rings in China, although it is possible that this Western practice might catch on in future.
A campaign to eradicate a huge fake diamond problem that existed as recently as 1993, has shored up confidence among consumers. There are now 80 jewellery testing centres in key markets and all purchasers of diamonds of above 10 points receive a certificate of authenticity.
The main target market is white-collar workers between 25 and 45 years of age, particularly those employed in the private sector. In Shanghai, 54 percent of wedding couples on middle incomes buy diamond rings, compared with 10 percent in the west. Earrings are relatively unimportant in China, making up 2-3 percent of all sales. Chinese consumers like the value concept, says Wu, in contrast to India, for example, where consumers prefer to own lots of small stones.
According to press reports, a couple from Zhejiang recently spent Yn230,000 on a diamond. However, the average price of an item of women's diamond jewellery is about Yn4,700, not far short of China's average annual urban disposable income of Yn6,280 in 2000.
Were it not for China's strict controls on the cross-border movement of capital, the government might view with equanimity the high price that diamonds command and the rapid increase of domestic sales. As it is, precious stones can be spirited out of the country with comparative ease, for instant conversion back into hard currency once abroad. Conversely, China's high tariffs encourage inbound smuggling, a threat to China's processors and their 2.4m carats in annual domestic production.
The smuggling problem remains quite serious, according to Wu. Much of China's relatively small output of diamonds is exported because it is not of the type or grade in demand locally. Therefore, domestic demand is satisfied through legitimate imports from Israel, South Africa and India along with the significant amounts brought in illegally.
Smuggling has increased with the growth in foreign travel by Mainland Chinese. Jewellery stores in Hong Kong are especially popular among Mainland tourists and they were the first retail outlets in the SAR to accept the Chinese currency.
Some industry observers believe that China will one day become the world's biggest market. However, Shanghai might struggle to establish itself among the family of elite diamond cities worldwide, even as the home market continues to expand. It must fight off emerging competition from nearby Thailand, Sri Lanka and Vietnam. Russia, the world's top diamond exporter, is in talks with India on processing. India processes US$8.5bn of diamonds a year and Mumbai is a leading re-exporter of cut stones.
Shanghai needs to enthuse more foreign producers and dealers. China's own output of diamonds is low, estimated at just 0.1 percent of the world carat total in rough diamonds and worth up to US$15m in 1999. De Beers, which is keen to participate in the rapidly developing consumer market, has been involved in China off and on since the 1950s. In recent years it has entered into prospecting joint ventures, although no viable deposits have yet been found.
Downstream operations need to move up a gear if the sector's aspirations are to be realised. Shanghai's diamond jewellery market is worth around Yn1bn a year (a fifth of the national total) and rising. There is scope for more cutting trade from foreign players as processing costs rise at established centres. In 1999, this was said to be worth US$520m in exports to the diamond cutters of Guangdong, Shandong and Shanghai. However, while the cutting business is growing, it is dwarfed by other markets, such as India.
China's polishing industry has grown steadily. It now employs about 11,500 workers in 70 factories and it enjoys low production costs, a fact that is attracting Belgian, Israeli, Indian and Thai companies to build new polishing factories. However, high taxes and travel restrictions mean that China cannot compete with companies in India that dominate the manufacturing of cheaper rough, but China is likely to take up some of the work currently done in Thailand.
Jewelery manufacturing is also well established and is likely to grow in future to meet rising local demand. Hong Kong companies dominate and many have negotiated operating licences for retail outlets in con-junction with local partners in the leading coastal cities.
Shanghai has set itself challenging goals – by 2010 it wants city diamond sales to reach up to US$5bn. Beyond this, by 2015, Shanghai has aspirations to become the largest diamond transaction city in Asia. Without the co-operation of the tax authorities, however, this will be difficult to achieve.
The prospecting industry
By world standards, China is a small producer of diamonds, currently producing about 100,000 carats of rough diamonds a year from its mines in Liaoning, Shandong and Hunan. This is out of a world total of some 110m carats. In future, there is likely to be a focus on finding new mines in central provinces, which have been explored Less extensively by Chinese geologists.
De Beers signed a three-year prospecting agreement with the Bureau of Geology and Mineral Resources in 1986 to prospect for Diamonds in Shandong province. It signed a similar agreement with the Liaoning bureau in 1988 but this was terminated four years later because of the lack of progress in developing a proper legal infrastructure. In 1997, the company signed joint venture agreements with the Ministry of Geology and Mineral Resources for prospecting in Sichuan and Hebei provinces.
Some uncertainty remains in the area of legal protection and there is also concern over the fiscal regime, and these factors are a barrier to more foreign involvement in diamond mining. ?A new diamond mine would cost well over US$500m, so the certainty of the investment regime is clearly of great importance,? said a statement by De Beers.
The worldwide mineral industry has recently been impacted by falling commodity prices, but diamond prices in China have remained relatively stable.