US embassy cable - 04YEREVAN1662

UNCLAS SECTION 01 OF 02 YEREVAN 001662 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR EUR/CACEN FOR SIDEREAS, EUR/ACE FOR LONGI 
 
E.O. 12958: N/A 
TAGS: ECON, ETRD, EINV, EIND, AM, RU 
SUBJECT: ARMENIA TRIES TO SQUEEZE VALUE FROM DIAMONDS 
 
1. (U) Sensitive but unclassified.  Please protect 
accordingly. 
 
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SUMMARY 
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2. (U) While constituting only 5 percent of GDP, Armenia's 
rapidly expanding diamond cutting industry attracts both 
strong domestic attention and significant foreign 
investment.  Precious and simple to transport, diamonds 
overcome Armenia's closed borders and high transport costs. 
A history of diamond cutting, low wages, and a preferential 
quota arrangement with Russia fueled early growth in the 
diamond sector.  Increases in diamond production have caused 
a sharp, albeit specious, increase in Armenia's trade 
numbers, and have proved a handy source of foreign currency. 
On the other hand, the industry brings almost no tax revenue 
to government coffers.  The government is looking to a new 
strategy to encourage diamond polishers to sell their 
diamonds and thus take their profits in Armenia.  Investment 
by the diamond industry's heavy hitters suggests that 
wholesale diamond sales could have a future in Armenia, 
which would transform the industry from an expanding source 
of jobs to a strong growth sector.  End Summary. 
 
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DIAMOND CUTTING HERALDS GROWTH IN EXPORTS... 
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3. (U) Strong growth in the diamond cutting industry has 
greatly expanded Armenia's external economy, despite having 
little effect on its domestic books.  Since 1998 exports of 
diamonds have increased seven fold to nearly USD 378 million 
in 2003 (imports of raw diamonds expanded from USD 45 
million to USD 343 million over the same period).  Exports 
of diamonds accounted for 53.5 percent of all exports and 
the continuing expansion of the inward processing diamond 
industry pushed up overall exports and imports markedly, 
causing trade to increase by 35 percent in dollar terms in 
2003. 
 
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...BUT NOT GDP 
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4. (U) Despite large effects on Armenia's trade statistics, 
diamond processing barely leaves a mark on Armenia's GDP, or 
for that matter, tax revenues.  The value added in diamond 
polishing is low, from 5 to 10 percent, and most diamonds 
are processed in Armenia and sold on low, cost-plus terms to 
parent companies abroad.  The diamond industry brings only a 
couple million dollars per year in profit tax revenue, and 
no VAT revenue as diamonds are exempted as an export 
industry.  Because Armenia captures so little of a diamond's 
value added in Armenia, the sector's value to the Armenian 
economy is in effect limited to the 5,500 jobs it provides, 
with average monthly wages of USD 300. 
 
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SQUEEZING VALUE FROM A DIAMOND 
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5. (SBU) According to Gagik Mkrtchian, Head of the 
Department of Gems and Jewelry at the Ministry of Trade and 
Economic Development, the government is seeking to capture 
more of the industry's value-added by encouraging wholesale 
sales of loose diamonds in country.  According to Mkrtchian, 
his office has submitted a plan to create a diamond sales 
center in Armenia that could be one-stop-shop for wholesale 
buyers, providing a forum for the diamond factories to 
exhibit diamonds and for buyers to secure necessary export 
and Kimberley process documentation.  While Mkrtchian's 
plans are still abstract, Armenia's largest diamond factory 
has put the same idea into bricks and mortar.  On a recent 
visit to the Shoghakn factory, owned by the world's largest 
private diamond manufacturer, Lev Leviyev, the factory 
manager showed the Ambassador a new building that has been 
finished as a showroom for wholesale buyers.  The manager 
said they intend to bring sales of wholesale diamonds to 
Armenia, operating from the factory showroom.  According to 
Mkrtchian, sales of finished loose diamonds could capture up 
to 30 percent of the diamond's value added in Armenia. 
While having little effect on the company's balance sheets, 
moving sales to Armenia could have a great effect on 
Armenia's books.  While sales would be exempt for VAT tax 
(diamonds are exempt until set into jewelry) any sales here 
would be revenues recorded in Armenia on which the Armenian 
incorporated subsidiary would have to pay profit tax. 
 
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BIG PRODUCERS LOOK BEYOND RUSSIAN SUPPLIES 
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6. (SBU) As the diamond sector expands in Armenia and the 
industry's largest players expand their operations here, the 
case for bringing sales here grows stronger.  The ultimate 
sustainability of Armenia's diamond sector depends on its 
diamond firms becoming global players and less dependant on 
waning Russian supply.  No factor is more important to the 
success of a diamond factory than ensuring a consistent 
supply of raw diamonds.  Of Armenia's 50 diamond-polishing 
factories, few are large players who can secure supply lines 
worldwide.  The Aslanian family, partnered with the 
prestigious diamond firm Rosy Blue, operates a diamond 
factory in Lori province supplied from Belgium with high 
quality diamonds from around the world.  Lev Leviyev, an 
Israeli (also a Russian citizen) billionaire from 
Uzbekistan, procures diamonds for his Shoghakn plant from 
various mines in Africa.  The Diamond Company of Armenia, 
owned by the British Ferfano Company, sources its production 
of 8,000 carats per month from De Beers. 
 
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SMALL PRODUCERS LOOK THREATENED 
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7. (SBU) Armenia's smaller producers depend on a 
preferential quota agreement with Alrosa, the Russian 
diamond supplier.  Each year the Russian government permits 
export of up to 400,000 carats of rough diamonds to Armenia, 
which are distributed among Armenia's operating diamond 
factories.  The actual number of diamonds received from 
Russia is much smaller.  In 2003 Armenian factories received 
only 130,000 carats of raw diamonds from Russia, and they 
have received 100,000 carats in the first six months of 
2004.  Shoghakn's general manager insists that Russian 
supply is increasingly less important as prices are rising 
and the quotas are unfulfilled.  Mkrtchian added that many 
of the smaller factories are now idle, and prospects for the 
future of Russian supply are not good.  As Russia moves to 
accede to the WTO, Mkrtchian reminded us, it must end 
preferential supply arrangements and Alrosa's quota system. 
Mkrtchian concluded that the future of Armenia's diamond 
industry depends on the leadership of the large diamond 
producers. 
 
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COMMENT 
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8. (SBU) As the preferential supply of Russian diamonds 
wanes, the future of Armenia's diamond sector depends on the 
ability of the GOAM to encourage the big producers to expand 
their Armenian operations and to consolidate efforts to 
bring buyers to Armenia.  The prospect of onward sales 
present tempting rewards for tax revenue, and Armenia has 
(rightly) chosen to tread lightly on the industry, exempting 
diamond producers from the VAT hassles that burden other 
exporters.  Diamond companies can easily shift production 
among their factories, and continued diamond-friendly tax 
policy will encourage the big producers to expand and open 
wholesale operations in Armenia. 
ORDWAY