THE DIAMOND CUTTING INDUSTRY AT CROSSROADS: THE

5
Industry
T H E DIAMOND CUTTING
INDUSTRY AT
CROSSROADS: T H E
IMPACT ON SRI LANKA
rThilan Wijesinghe:
Formerly Senior Consultant at Coopers & Lybrand (Management Consultancy Division)
and since January 1991, Manager - Planning & Special Projects at Sampath Bank,
1.0 I n t r o d u c t i o n
« r * * t present the diamond cutting in­
dustry is in a d e p r e s s e d state. Worldwide
over-capacity in cutting and polishing,
combined with increases in the price of
rough diamonds and w e a k d e m a n d in
the traditional retail markets of U S A and
J a p a n , and m o r e recently, the Gulf cri­
sis, h a v e contributed to the present situ­
ation. T h e industry is n o w in the process
of rationalising itself to meet the n e w
challenges a h e a d .
T h i s article broadly analyses the events
leading to the current situation and at­
tempts to a s s e s s its impact on the dia­
mond cutting industry in Sri L a n k a and
presents strategies for promoting invest­
ments with this sector.
2.0 Brief O v e r v i e w o f t h e D i a m o n d
C u t t i n g I n d u s t r y In S r i L a n k a
T h e evolution of diamond cutting into
an important domestic export industry in
Sri L a n k a c a n b e considered a result of
the following factors, listed according to
the probable order of importance:
(a) a n innate ability to obtain the best
"make" from rough diamond.
(b) g o o d eyesight combined with a high
d e g r e e of.nianuaMexterity.
(c) high literacy rate, a n d the ability to
follow simple instructions - i.e. high
degree of trainability.
Economic Review May/June 1991
(d) low w a g e structure.
In general, it c a n be stated that a
centuries old history In gemming and a n
artisan culture, combined with a national
a v e r a g e literacy rate of o v e r 85% h a v e
helped foster within Sri L a n k a a labour
force ideally suited for diamond cutting.
T h e estimated export performance of
Sri Lanka's diamond industry is s h o w n
below:
Year
1982
1983
1984
1985
1986
1987
1988
1989
j
Exports
( R s . Million)
219
449
273
434
1215
1248
1629
3225
S o u r c e : Export Development Board.
Diamond exports h a v e g r o w n from
about R s . 220 million in 1982 to R s .
3225 million in 1989, according to E x ­
port Development Board statistics. T h i s
represents a n e x c h a n g e rate - adjusted
c o m p o u n d annual a v e r a g e growth rate
of about 34% for the period. In 1989;'Sri
L a n k a had about 3000 cutters, and the
a v e r a g e output from 12 factories in
operation totalled around 25,000 carats
per month. Although significant growth
has b e e n accomplished in the past, Sri
Lanka's output still remains a n insignifi­
cant 0.25% of the world's d e m a n d for cut
and polished diamonds, estimated at
ov.er U S $ 20 billion per year.
F o r the s a k e of comparison, if the per­
formance of the garment industry is
compared with that of diamond cutting,
'although no correlation exists between
the t w o except they h a v e both been high
growth export industries'in Sri Lanka, it
c a n be s h o w n that garment exports far
e x c e e d diamond exports in terms of
value a s well a s employment generated.
In 1989, o v e r 350 factories w e r e operat­
ing in Sri L a n k a exporting about R s . 17
billion in garments, more than 5 times
the value of diamonds exported.
T h e parallel which c a n be d r a w n h e r e
is that in considering the relatively supe­
rior skills in diamond cutting available in
Sri L a n k a , a n d probably a greater c o m ­
parative advantage in comparison to
garment manufacture, the export growth
performance of the diamond industry
during the last 3 y e a r s has been s o m e ­
what limited. Most of the real growth In
exports recorded appears to result from
existing factories expanding production
rather than h e w entrants into the busi­
ness. In an industry which held m u c h
promise for growth in the 1980's only
about 11 factories c o m m e n c e d opera­
tions during this decade. H e n c e there
appear to be significant barriers to entry
into diamond cutting from the point of
v i e w of local investors.
Briefly, the main barriers to entry into
this business are g i v e n below:
(a) extended learning c u r v e in achieving
full productivity, and the n e e d to rely o n
expatriate trainers at v e r y high cost.
(b) limitedsuccess b y Sri Lankan inves­
tors in identifying joint venture partners
and/or suppliers of rough arid distribu­
tors of polished g o o d s in major trading
centres s u c h as A n t w e r p and T e l - A v i v .
In comparison, Indians are in a favour­
able position to obtain reliable supplies
of rough and market finished goods d u e
to a large Indian-community taking up
residence in A n t w e r p durig the early
1970's.
T o d a y m o r e than 100 Indian families
h a v e at least o n e m e m b e r / e s i d i n g In
S3
A n t w e r p , thus forming a n invaluable link
b e t w e e n the 4 trading floors in A n t w e r p
a n d the cutting factories of India. Similar
family ties h a v e b e e n established be­
t w e e n the J e w i s h community in A n t w e r p
a n d cutting factories in Israel. T h e r e f o r e
the traditional family ties prevalent in the
b u s i n e s s automatically places a poten­
tial Sri L a n k a n Investor at a comparative
d i s a d v a n t a g e in establishing links for
supply a n d marketing.
(c) t h e d i f f i c u l t y I n r a i s i n g w o r k i n g
c a p i t a l f i n a n c i n g . F o r e i g n suppliers,
particularly in the c a s e of n e w factories,
often i m p o s e the burden of purchasing
r o u g h outright o n local investors and
require up to 60 d a y s credit for market­
ing. T h u s large s u m s of working capital
financing a r e required, with banks g e n ­
erally requiring 100% security c o v e r o n
their e x p o s u r e . (Diamond stock is u s u ­
ally not accepted a s collateral).
(d) m u l t i p l e f o r e i g n e x c h a n g e c o n ­
version a n d bank charges. Exchange
Control regulations h a v e also affected
the industry since diamond exporters,
other than the f e w 100% foreign o w n e d
c o m p a n i e s , are required to carry out
multiple foreign e x c h a n g e conversions
w h e n effecting imports a n d exports.
T h e s e multiple dollar-rupee-dollar c o n ­
versions result in additional b a n k c h a r g e s
w h i c h e r o d e profit margins available to
cutting factories.
v
T h e a b o v e factors, combined with the
inherent fluctuations in the diamond
market h a v e contributed towards inhib­
iting the g r o w t h of this industry in Sri
L a n k a . In the following paragraphs,
strategies to e n h a n c e the country's c o m ­
petitive position a r e d i s c u s s e d .
3.0 T h e D i a m o n d I n d u s t r y - T h e
Global Situation
3.1 O v e r v i e w
After nearly 9 y e a r s of steady growth
in turnover a n d profits, the diamond
cutting industry is presently undergoing
difficult times.
Israel, w h i c h p r o c e s s e s almost half
• the value of the world's rough diamonds
h a s s e e n a 2 0 % decline in carats proc­
e s s e d this y e a r a s c o m p a r e d to 1989.
S o m e of the country's 700 or s o facto-'
54
ries h a v e either closed d o w r y e t r e n c h e d
w o r k e r s or m o v e d into the trading busi­
n e s s . India b y far h a s b e e n worst af­
fected b y the present recession facing
the industry. In a country in w h i c h about
800,000 w o r k e r s a r e directly or indi­
rectly involved in diamond cutting, at
least200,000 a r e reportedly out of work.
T h e folowing paragraphs attempt to
analyse the underlying reasons for this
slump a n d presents the prognosis for
the future of this industry.
3.2 F a c t o r s A f f e c t i n g C u t t i n g
Industry
T h e present slump faced b y the dia­
m o n d cutting industryfor small stones is
a result of a series of e v e n t s , involving
the D e B e e r s diamond cartel, cutting
factories a n d retail markets in general.
G i v e n below is a s u m m a r y of s o m e of
the e v e n t leading to the present situ­
ation. T h e s e e v e n t s , although inter-re?
lated, a r e not necessarily in the s e ­
q u e n c e in w h i c h they occurred.
E x p a n s i o n In India
T h e mid to late 1980's w e r e v e r y
profitable y e a r s for the cutting industry
with the expansion fuelled b y strong
economic g r o w t h worldwide. In particu­
lar, industrialists cutting and polishing in
India w e r e making sufficiently large
profits w h i c h enabled them to:
(a) e x p a n d capacity, and
(b) purchase rough diamonds from
s o u r c e s other than their traditional s u p ­
pliers at higher prices for purposes of
stockpiling a n d cutting and polishing.
D u e to strong market d e m a n d , the Indi­
ans w e r e able to m a k e adequate profits
by paying premium prices for rough
diamonds.
T h e a b o v e situation led to an o v e r s u p ply of low quality, c h e a p Indian g o o d s
being d u m p e d into the market. T h i s
eventually contributed towards a n over­
all depression in pricestbr most small to
medium s i z e d diamonds.
Increase in t h e C o s t o f R o u g h Dia­
monds
Partly top s t e m the Indian expansion
in cutting capacity and stockpiling, the
Central Selling Organisation of D e Beers
increased prices of rough diamonds b y
about 25% a n d 5.5% in 1988 a n d 1989
respectively.
S l a c k e n i n g o f D e m a n d i n M a j o r Retail
Markets
J a p a n and U S A account for more than
65% of global sales in cut and polished
g o o d s . T h e fall of the y e n against the
dollar and the financial turmoil in T o k y o
combined with-a- weakening U S e c o n ­
o m y has contributed to the general slow­
d o w n in d e m a n d .
G e n e r a l Shift i n C o n s u m e r P r e f e r ­
ence
With the glut of badly m a d e Indian
g o o d s resulting in a n overall depression
ofprices, c o n s u m e r s found small g o o d
of a better " m a k e " affordable a n d per­
ceived them as a better investment stone
(the "make" of a diamond refers to the
quality of the cut a n d clarity). T h e r e f o r e ,
in broad terms the market d e m a n d for
small diamonds shifted towards better
quality, with customers being more s e ­
lective of g o o d s purchased.
T h e combined effect of the a b o v e fac­
tors has been the erosion of profits
margins to cutting factories and a n e n ­
suing rationalisation of cutting capacity
through closures and lay-offs.
T h e net result has b e e n that cutting
factories h a v e b e e n on their o w n accord
forced to obtain better market prices for
finished g o o d s to remain profitable. T h e
only w a y of achieving this desirable e n d ,
in a n environment of increasing prices of
rough and slow d o w n in d e m a n d in tra­
ditional markets, h a s b e e n to produce a
better quality stone a n d m o v e up-mar­
ket.
Invariably this would m e a n better
production m a n a g e m e n t a n d the u s e of
improved technology which automati­
cally places the Indian industry at a dis­
advantage since it functions primarily o n
a sweat-shop/cottage industry type
model, making quality control difficult.
4.0 O u t l o o k f o r t h e D i a m o n d C u t t i n g
Industry In S r i L a n k a
4.1 O v e r v i e w
A s pointed out previously, the dia­
m o n d cutting industry is at crossroads.
Economic Review May/June 1991
Industry
With significant shifts in c o n s u m e r
d e m a n d patterns, increasing prices of
rough and o v e r capacity in cutting the in­
dustry is n o w undergoing a process of
rationalisation. A n a l y s e d below is Sri
Lanka's position vis-a-vis this changing
environment.
4.2 I m p a c t o n L o c a l F a c t o r i e s
In comparison to India, the impact o n
local factories arising from a d v e r s e trad­
ing conditions has b e e n minimal. T h i s
has b e e n primarily d u e to the Sri L a n k a n
diamond industry functioning according
to an "organised factory" model a s op­
posed to the "cottage industry" model
prevailing in India.
T h e organised factory concept allows
Sri Lankan facilities to consistently pro­
duce better quality g o o d s w h i c h are
marketable in relation to Indian g o o d s of
poor "make*. T h u s profit margins to local
factories, although comparatively less
than margins obtained during the b o o m
y e a r s b e t w e e n 1984 and 1988, h a v e
b e e n adequate to remain in business.
In contrast, the cottage industry model
m a k e s quality control virtually impos­
sible since a single supplier usually
supplies rough diamonds to literally d o z ­
e n s of sweat s h o p s ; the supplier then re­
c e i v e s finished g o o d s w h i c h a r e of in­
consistent quality, thereby not being
able to c o m m a n d premium prices in the
market place. Furthermore, these s w e a t
shops a r e often poorly lit, lacking in air
conditioning, with equipment rarely main­
tained a n d balanced, a n d w o r k e r s are
often plagued with poor eyesight a n d
poorly remunerated. T h e combined ef­
fect of these factors is a poor quality
product.
H o w e v e r , virtually all Sri L a n k a n facto­
ries operate as well organised produc­
tion s y s t e m s , with air conditioning, suf­
ficient lighting and a relatively comfort­
able working environment. V e r y often
quality control standards are stringent.
T h e r e f o r e loss of jobs h a v e b e e n mar­
ginal resulting from the current e v e n t s in
the market place. N e v e r t h e l e s s , it is
reliably understood that about 200 to
300cutters h a v e either b e e n retrenched
or h a v e voluntarily left their jobs d u e to
the current industry slump. Contributing
Economic Review May/June 1991
to this h a s b e e n the introduction of m o r e
stringent quality standards resulting in
the daily output of these w o r k e r s drop­
ping below acceptable standards. T h i s
m e a n s lower earnings since w a g e s are
linked to productivity a n d quality.
T h e a b o v e suggests that the Sri L a n k a n
factories a r e better equipped to c o m ­
pete in the market place than their Indian
counterparts. H e n c e it is realistic to a s ­
s u m e that if the Indian industry is to
remain competitive, cutting and polish­
ing operations n e e d to bo structured a s
a n organised production s y s t e m .
H o w e v e r this is not b e a realistic op­
tion in the near term d u e to e x c h a n g e
control laws, taxes a n d a frustrating
bureaucracy prevailing in India. T h e pres­
ent cottage industry model offers the
Indian diamond trader an, ideal m e a n s of
operating through the black market.
Furthermore, channels for smuggling
diamonds in and out of India h a v e b e e n
established o v e r several d e c a d e s a n d it
is unlikely that there will be a significant
shift in the overall structure of the Indian
industry into the organised factory model.
A more likely event would b e the overall
paring d o w n of the cottage industry op­
eration to manageable levels with liter­
ally thousands out of employment per­
manently.
In the final analysis, the erosion of
margins to the cutting industry has
meant that the Israeli industry is affected
d u e to high labour costs and the Indian
industry d u e to poor quality. T h i s situ­
ation presents a n attractive opportunity
for Sri L a n k a to penetrate the market
further to pick 'up the slack in the
industry, since under prevailing market
conditions for small stones, Sri Lanka's
competitive position is e n h a n c e d d u e to
its low w a g e structure and reputation
for quality. H e n c e a n argument c a n be
p r e s e n t e d y h a t Sri Lanka's industry
,,|W|<
should be poised for e x p a n s i o n .
§ J T t t o Potential f o r G r o w t h
B a s e d o n the a b o v e analysis, it is rea­
sonable to a s s u m e that the cutting and
polishing of diamonds in Sri Lanka has
the potential to g r o w into a major export
industry, generating significant gains in
employment and net foreign e x c h a n g e
earnings. If Sri L a n k a achieves a mere
5% s h a r e of t h e world's market for cut
and polished stones, it c a n be roughly
estimated that m o r e than 60,000 w o u l d
gain direct employment, about 20 times
m o r e than the present levels. Achieving
significant growth within this export
industry is m a d e possible in considering
that:
(a) it is generally acknowledged that the
a v e r a g e productivity of Sri Lankan la­
bour is superior to that of India, Thailand
and China.
(b) d u e to the inherent multiformity of
diamonds, automation in cutting and
polishing is not e x p e c t e d to significantly
.diminish the importance of manual la­
bour in the long term.
the rationalisation presently under­
w a y within the industry is expected to ir­
reversibly e n h a n c e the competitive
position of low cost, high quality produc­
ers s u c h a s Sri L a n k a .
H o w e v e r , the a b o v e optimism does
not necessarily lend itself to Sri L a n k a
embarking o n a hastily executed large
ecale capacity expansion programme; it
merely suggests that if properlyplanned,
the potential exists for Sri Lanka, with its
liberal e x c h a n g e control laws, z e r o taxa­
tion o n exports, highly trainable labour
and experience in operating large scale '
organised factories, to become the major
growth centre for diamond cutting in the
1990's.
ill
55'
T h e argument against setting up n e w
factories, b a s e d o n the present industry
situtation is that:
(a) a n e w factory's output during the
initial 1-2 y e a r s of production is usually
of a poorer "make" a n d l o w e r y i e l d d u e t o
the relatively lengthy learning c u r v e in- .
herent to diamond cutting; and as stated
previously, the market for lower quality
g o o d s is w e a k .
(b) due to A n t w e r p ' s general reluctance
to supply n e w factories, on a "cutting fee"
basis, e n h a n c e d by the fact that Sri
L a n k a n s d o not h a v e ethnic links to the
trading floors of E u r o p e , n e w factories
are additionally burdened with raising
vast amounts of working capital finance
(usually running into more than three
times the cost of plant and equipment)
a n d bearing the interest cost thereon.
T h e r e f o r e factories commencing o p ­
erations in the present business envi­
ronment are subject to s e r v e r e financial
constraints through the combined ef­
fects of profit margin erosion,- high fi­
n a n c e c h a r g e s and costs of expatriate
trainers. In the final analysis, starting a
new factory currently would m e a n e x ­
traordinary losses during the initial y e a r s
of operation; and unless the market picks
up dramatically, getting, started in dia­
m o n d cutting must necessarily be lim­
ited to parties with sufficient financial
cloutto withstand initial losses and those
w h o are committed to long term profits
and returns.
It is therefore natural to question a s to
w h a t point in time a n e w Sri L a n k a n dia­
m o n d factory c a n operate a s a viable
c o n c e r n . T h e a n s w e r is a s s o n a s the
factory h a s adequately demonstrated to
A n t w e r p that:
(a) it is o w n e d and operated b y individu­
als (preferably family m e m b e r s ) of im­
peccable repute a n d financial stability.
(b) the factory h a s sufficient installed
capacity, is well m a n a g e d a n d its output
is of a consistently goodWke".
O n c e t h e s e attributes are d e m o n ­
strated, the v e r y supliers w h o initiallyw o u l d h a v e required the Sri L a n k a n
factory to p u r c h a s e rough diamonds
t h r o u g h t h e m o n C O D terms a n d b e paid
56
for polished w h e n sold would b e willing
- to take the "risk" of supplying rough
diamonds, in v e r y large quantities o n a
cutting fee basis.
At present there are m a n y reputed
traders w h o are also site holders in
A n t w e r p willing to supply to Sri Lanka,
s a w n g o o d s and makeables of about 10
pointers rough on a cutting fee ranging
from U S $ 0.75 to U S $ 2.00 per stone.
H o w e v e r supply is contingent on the
factory having b e e n operational for about
18 months. A l s o exhaustive c h e c k s
would be carried out o n the quality of the
output and production methods a s well
as the financial strength and standing of
the o w n e r s . T h e latter is n e c e s s i t a t e d in
considering that the diamond business
is carried out largely o n trust; a n d d o c u ­
mentary letters of credit w h i c h prevail in
tradition import/export businesses are
the exception rather than the n o r m .
B e c a u s e s o m e dealers in A n t w e r p are
willing to supply rough diamonds in
quantities exceeding 100,000 stones
per month o n a cutting fee basis, only to
existing factories in Sri L a n k a passing
an equivalent of a l i t m u s test" in dia­
m o n d cutting, literally millions of rupees
of potential foreign e x c h a n g e earnings
are lost to the country. F o r example-it
c a n b e roughly estimated that a factory
cutting and polishing 100,000 s w a n
pieces a month would create employ­
ment for about 450 persons a n d net for­
eign e x c h a n g e earnings would total
about R s . 50 million per y e a r .
ments with Sri L a n k a n investors o n the
following basis:
(a) n e w factories with u n p r o y e n c a p a ­
bility would h a v e to purchase rough
diamonds o n C O D terms from suppliers
w h o will retain a brokerage commission
of upto 2%. W h e n cut and polished, the
diamonds would be marketed b y the
s a m e supplier w h o would again retain a
commission of upto 2%. E x p o r t s from
Sri L a n k a would be o n documents
against acceptance with the period of
the draft averaging a r o e u n d 60 d a y s .
T h i s m e a n s that the local factory, would
n e e d to carry the burden of a large
working capital financing facility to c o v e r
around 30 d a y s of r o u g h s t o c k a n d 60
d a y s of receivables. T h i s model involves
no risk to the supplier w h o would a g r e e
to supply rough and market polished at
best prices prevailing in the market; his
reputation in the trade would b e the main
yardstick available to the Sri L a n k a n in­
vestor to ascertain that the supplier is
acting in g o o d faith.
f
(b) once a n e w factory h a s established
itself as a reliable manufacturer, usually
possible after 12 to 24 months of o p e r a - .
tions depending o n the quality of m a n ­
agement, the A n t w e r p traders would
willingly supply diamonds on a cutting
fee basis. T h u s the n e e d to tie-up local
working capital finance for diamonds is
minimised. In certain c a s e s the supplier
m a y e v e n take equity in the Sri L a n k a fa­
cility to partially finance capacity e x p a n ­
sion.
H e n c e Sri Lanka's Industry faces a
conflicting situation: high labour costs
and poor quality having contributed to
m a n y factory closures in Israel a n d
India respectively, diamond dealers are
looking towards alternate s o u r c e s for
cutting a n d polishing diamonds. H o w ever, Sri Lanka, a s a relatively efficient
producer has insufficient capacity a n d
skilled operators to meet this d e m a n d .
Moreover, foreign investors are g e n e r ­
ally reluctant to take equity in factories
located in Sri L a n k a d u e to cutting facto­
ries being inherently difficult to m a n a g e
from abroad, lack of family ties ' a n d
general preference to m a k e profits from
trading rather than manufacturing.
Note that the transition from the first to
the s e c o n d model is a reflection of the
supplier's willingness to reciprocate the
"trust" placed in him a n d analogous to a
successful courtship leading to marriagel
Ideally, a "mature" diamond cutting
factory in Sri L a n k a should b e operating
o n both models. T h e first model enables
the Sri L a n k a factory to obtain a higher
value a d d e d , particularly w h e n market
conditions are propitious. T h e latter al­
lows the factory to e x p a n d production at
a faster rate without the burden of ob­
taining e n h a n c e d facilities for working
capital financing and offers protection,
against market downturns.
Nevertheless, reputed sight holders in
A n t w e r p are willing to enter into a g r e e ­
Nevertheless, the critical issue this re­
port w i s h e s to address is that the road to
Economic Review May/June 1991
achieving "matured factory" status is a
difficult o n e , and which m a n y Sri Lankan
investors are reluctant to take in view of
short term losses and other constraints
discussed previously, it can therefore be
argued that a situation has arisen w h e r e
Sri Lanka's private sector is unable to
take advantage of a potentially lucrative
long term business opportunity without
the benefit of G o v e r n m e n t policy con­
cessions directed exclusively towards
promoting this industry.
6.0 G o v e r n m e n t P o l i c y I s s u e s
T h e incentives for developing the dia­
m o n d cutting industry should primarily
be directed towards minimising the bar­
riers and constraints faced by entrepre­
neurs during what can be termed as the
"incubation period" of a n e w diamond
cutting factory. T h a t is the period from
start-up, to having a fully trained contin­
gent of w o r k e r s required to qualify for re­
ceiving g o o d s on a cutting fee basis,
w h i c h under normal circumstances
should not be greater than 2 y e a r s .
with foreign equity, shold be granted to
100% locally o w n e d diamond cutting
factories. This concession has the added
benefit of lower interest rates which is a
critical factor affecting competitiveness
in the diamond industry w h e r e working
capital e x p o s u r e is high. T h i s facility
should replace the Central Bank refi­
nanced packing credit s c h e m e which
is inefficient in the context of the norms
of trade prevailing in the diamond in­
dustry. (Note that during the 1960'sand
70's c h e a p interest w a s vital in giving
Israel's diamond industry a competitive
edge o v e r many of their rivals in A n t w e r p
and N e w Y o r k , w h o w e r e more depend­
ent on the changing s e a s o n s of c o m ­
mercial rates.)
diamond cutting centres canot be e m ­
phasised e n o u g h . S c h e m e s such as
"Imprest S y s t e m s " , margin accounts
and trust receipts have been used by
commercial banks in these cities to fa­
cilitate obtaining working capital finance.
H o w e v e r the critical attribute required of
bankers to the diamond industry, which
is lacking in Sri L a n k a , is a specialised
knowledge of the business (valuation
techniques, market trends) and that of
the individual diamond manufacturer,
(factory capacity, production techniques,
security s y s t e m s e t c . ) .
(d) extension of pre-shipment credit
guarantees by the Sri L a n k a Export
Credit Insurance Corporation ( S L E C I C )
T h i s report does not attempt to g o into
a lengthy discourse on the range of
incentives which should be made avail­
able to the diamond industry, but high­
lights critical issues which n e e d to be
a d d r e s s e d w h e n deciding on G o v e r n ­
ment policy options for promoting this
sector. Consideration should be given to
the following:
(a) loans at concessionary interest
rates to finance the cost of expatriate
trainers and exemption from the 25%
tax on total emoluments for such train­
ers. (At present the Export Development
Board has a loan s c h e m e for n e w facto­
ries to finance 50% of training costs,
carrying aninterstrate of 5%per a n n u m ,
repayable o v e r 5 y e a r s . Ideally this
s c h e m e shold c o v e r factories choosing
to e x p a n d capacity as well).
(b) facilities to operate U S dollar ac­
counts though Foreign C u r r e n c y Bank­
ing Units ( F C B U ) of local commerical
banks, for the purpose of using export
proceeds to pay for imports,
thus
avoiding multiple foreign e x c h a n g e c o n ­
versions which result in e x c e s s i v e bank
charges and erosion of profit margin.
Permission to operate F C B U accounts,
though presently granted to companies
Economlc Review May/June 1991
(c) establishing separte "Diamond Di­
visions" within local commercial banks
specialising in meeting the financing
needs of this sector. T h e role played by
commercial banks in the evolution of
Antwerp, T e l Aviv and Bombay into major
at a higher level than has hitherto b e e n
offered to other export industries. A c a s e
can be made that in v i e w of the v e r y high
value of the imported input in diamond
cutting, the insurance c o v e r offered to
commercial banks under the Pre-ship-
57
Industry
merrt Credit G u a r a n t e e S c h e m e of
S L E C I C should be increased from
66-2/3 percent to 90 percent with a v i e w
to promoting this industry.
(e) creation of a special task force c o n ­
sisting of representatives from the Dia­
m o n d Manufacturers Association, rele­
v a n t G o v e r n m e n t ministries a n d invest­
m e n t approving agencies and c o m m e r ­
cial banks in formulating specific poli­
c i e s and guidelines in promoting this in­
dustry. T h e terms of reference of s u c h a
committee must include the carrying out
of a n indepth study of the functioning of
the cutting industry in established and
emerging centres s u c h as A n t w e r p , T e l
A v i v , B o m b a y , Bangkok a n d Beijing and
recommending policy m e a s u r e s to pro­
mote similar growth in Sri L a n k a .
In considering the a b o v e , it should be
noted that Sri L a n k a has not historically
targeted policy concessions to d e v e l o p
o n e specific industry. T h e r e f o r e , the
implementation of these r e c o m m e n d a ­
tions would result in representations b y
exporters that s u c h m e a s u r e s should
necessarily benefit other export indust <es as well. T h e following arguments
.can be presented to justify preferential
treatment for the diamond sector:
(a) Historically, the growth in diamond
cutting and polishing and subsequently
trading within the world's major cutting
centres e v o l v e d as a result of G o v e r n ­
ment policies specifically directed to
promoting this industry.
(b) Diamonds being the most c o n c e n ­
trated from of value a m o n g all traded
commodities, the working capital e x p o ­
sure in relation to fixed assets employed
is m u c h higher than a n y export industry
in Sri L a n k a .
(c) In v i e w of a lengthy learning curve
w h e r e operators m a y take more than
o n e y e a r to a c h i e v e full productivity, e x ­
patriate trainers a r e required for a rela­
tively long period of time at high cost.
(d) V e r y often net foreign e x c h a n g e
earnings as a percentage of net sales is
presented a s an important m e a s u r e in
qualifying for special investment incen­
tives. T h i s is a misleading indicator in
.the context of diamonds w h e r e value
.58
addition in percentage terms generally
ranges from 8 - 2 0 percent depending
o n the type of rough diamonds proc­
e s s e d . H o w e v e r in absolute terms, net
earnings in foreign e x c h a n g e from dia­
m o n d exports can far e x c e e d other
exports d u e to the high value of the c o m ­
modity.
(e) T h e e x p a n s i o n of this industry,
quite apart from generating significant
employment c a n lead to the establish­
ment of a major diamond e x c h a n g e in
Sri L a n k a , bringing together interna­
tional b u y e r s and sellers, and contribute
towards expanding the jewellery export
industry a s well.
It should b e noted that the manufac­
turing sector in Belgium and Israel h a v e
responded to the loss of comptitiveness
to low w a g e countries by successfully
. computerising almost all the p r o c e s s e s
-Involved in transforming diamond rough
* into cut and polished stones. T h i s tech­
nology is k n o w n to increase labour porductivity b y 4 to 8 time that of manual
methods. H o w e v e r presently the cost of
automation is high and this technology
cannot be u s e d o n all types of rough
diamonds and limited to producing the
brilliant cut only. T h e r e f o r e the impor­
tance of the labour input prevails.
Nevertheless, in the medium to long
term, there is no warrant for assumption
that relatively c h e a p labour rates will
continue to be available in Sri L a n k a and
automated technology would remain
costly and limited in its applications.
T h e r e f o r e , o n e should expect that if Sri
L a n k a is to remian competitive in the
long term, this industry should be g i v e n
the n e c e s s a r y incentives to e x p a n d its
manufacturing b a s e in the short term so
that profits c a n be invested in n e w tech­
nologies being e v o l v e d .
7.0 C o n c l u s i o n
eign investment in this sector.
If the history of cartelisation is a n a ­
lysed for this century, without any doubt,
the D e Beers diamond cartel can be
considered the most successful. T o
enter into this exclusive "fraternity" of
diamond cutters and traders, one must
necessarily p r o v e oneself worthy of
"membership". U p o n entry into this
diamond fraternity, the cartel treats
' t h o s e falling in line with its policies and
guideline benevolently, ensuring that
traders and cutters shall make ade­
quate profits in the long term, though
short term windfall profits and losses
are inevitable. E v e n the slightest viola­
tion of the "trust factor", all important to
the functioning of this industry, would
m e a n expulsion from this inner circle
and re-entry into the business could
literally take a g e n e r a t i o n , if at all. Simi­
larly traders, prior to benefitting from
the supply of rough o n favourable terms,
and equity participation.
T h e r e f o r e e v e n if g o v e r n m e n t policies
are in place to assist local entrepre­
neurs during the s o called incubation
period, it can b e q u s t i o n e d whether Sri
Lanka's private, sector has the resolve
and the requisite management skills
(having b e e n pampered o n industries
and business opportunities yielding short
terms profits,) to weatherthe initial losses
in anticipation of long term profits, char­
acteristic to diamond cutting. In the ab­
s e n c e of ethnic and family ties to the
major diamond trading floors of the
world, there are no short cuts to success
in this industry.
Thailand and C h i n a are emerging as
n e w growth centres for cutting and pol­
ishing in competition with Sri L a n k a a n d ,
if Sri L a n k a is to fully exploit her c o m ­
parative advantage o v e r t h e s e two coun­
tries, the G o v e r n m e n t must e x t e n d c o n ­
cessions to nurture the local industry
through its incubation period as referred
to a b o v e . T h e s e concessions are e s ­
sential in considering the inherent closed
nature of the diamond business and
would eventually result in greater for­
Economic Review May/June 1991