Israel’s Diamond Industry in Drive to Restore Its Lost Luster

A scandal, a credit crunch and a new tax regime has hurt the industry over the past two years, but the sector is fighting back on all fronts.

Bloomberg

The Israeli diamond industry has seen its glow diminish over the last two years, but the industry, a leading employer and exporter, is determined to restore its luster.

The problems started in 2012 with the exposure of an underground bank operating in the industry. It grew worse with a decision by the Tax Authority to amend its tax treatment of diamond dealing and worse when Bank Leumi announced in April it was getting out of the business of lending to the industry. Then came Operation Protective Edge, which scared away investors and caused the postponement of a key buyers conference.

“We’ve gone through a problematic period with the war,” says Shmuel Schnitzer, president of the Israel Diamond Exchange. “During the first half of 2014 there was a rise in [diamond] exports — not meteoric but 3.5% to 4% — and then came July, and exports retreated 15%. There was an atmosphere of stagnation. We count on buyers coming to Israel. In July only a few buyers came, and they received a letter of appreciation from the exchange because they came in spite of the situation.”

When the hostilities in Gaza ended, the buyers returned to the Diamond Exchange in Ramat Gan, which is on the border of Tel Aviv. But a large part of the damage was irreparable. International Diamond Week, which was scheduled for early September, was supposed to boost diamond sales in the second half of the year, especially around Christmas, which is the peak season for the industry. The war was over and some 400 buyers were due to arrive, but there were doubts about whether the cease-fire with Hamas would hold.

“We were forced to postpone the conference to October, which isn’t as good because sales in advance of Christmas are made in September to give enough time to set the diamonds,” says Schnitzer.

The underground bank police uncovered two years ago was actually operating inside the Diamond Exchange and had laundered 1 billion shekels of cash. Diamonds and documents were confiscated, bank accounts were frozen and liens were placed on diamond dealers’ homes.

Two months ago the Tel Aviv District prosecutor for tax and commercial crimes filed the first three indictments in Tel Aviv District Court against the prime suspects for money laundering, tax violations and other offenses.

Dialogue
with the taxmen

“We’re doing everything [possible] so the underground bank affair will become a legacy of the past,” says Schnitzer. “We are reorganizing the diamond industry, we are having a dialogue with the Tax Authority, and I feel we are making good progress. The industry is ready for a significant change.”

The tax issue remains, however, unresolved. Diamond dealers do not pay the regular corporate tax rate of 26.5% of profits; instead they are liable for a rate of 1.3% of their turnover. This is a historical arrangement from the times when it was hard to track diamond deals, which are traditionally conducted with no more than a handshake and no documentation.

Last year, a proposal for a new policy was formulated, which included a fine that would have been imposed on the entire industry for alleged past debts. But diamond dealers, who claim they have always paid all the tax due, refused to pay the fine while the State Prosecutor’s Office rejected the compromise.

Schnitzer refuses to discuss it, so as not to damage the new deal the Tax Authority is negotiating with the industry.

There is deep disappointment in the diamond industry about the decision by Leumi, which traditionally accounted for about 20% of all lending to the industry and single-handedly created a credit crisis by pulling out. Bank Hapoalim, the other of Israel’s two big banks, has traditionally avoided the business.

“Leumi’s departure fell on us like thunder on a clear day,” says Schnitzer. A bank like Leumi cannot pull out of the industry, which makes up 20% to 25% of all of the country’s industrial exports, in only a couple of months and leave a vacuum,” he warns.

Israel Discount Bank and the State Bank of India, which operates in Israel, are still lending to the industry, but Schnitzer says officials are trying to tap new financing sources, because banks face regulatory ceilings on how much they can lend to any one sector.

“One of the banks joined with an investment fund, and together they are bringing in tens of millions of additional dollars to the industry. This initiative is supposed to start in the next few weeks. We’re in touch with two other funds to help finance the industry The credit is needed so diamond dealers can provide credit to their customers. If I can’t offer credit to a buyer, he’ll buy the diamonds somewhere else,” explains Schnitzer.

To keep growing, the industry needs to double its present credit lines to $2.5 billion to $3 billion. The Diamond Exchange has been discussing with another investment fund providing loans using real estate as collateral and has retained the accounting firm BDO to find other funds interested in providing further non-bank credit.

Apart from the local problems of the underground bank, taxes and Leumi’s exit, Israel, like the rest of the global diamond industry, has had to deal with rising prices for rough diamonds, which it has not been able to fully pass on in the price of finished products. That has eroded profitability for diamond dealers and polishers alike.

The uncut diamond business is controlled by five or six multinational companies, including De Beers and Alrosa, which ensures the high price of rough diamonds.

“If these companies don’t sell their rough diamonds for months, it won’t bankrupt them,” says Schnitzer. “But producers can’t hold inventories of diamonds, so the market determines the price. I don’t think there is any price coordination between them, since they are rather concerned about the [antitrust] authorities, but naturally information on prices leaks out, which creates a benchmark for everyone.”

Israeli diamond dealers now have deals with African nations not only mining diamonds but polishing the stones, too, which has led Israelis to open polishing operations in Africa.

African competition

“They want to profit all along the downstream, to produce and market, and they are stepping into our shoes as manufacturers. The big problem is that De Beers, which controls [the industry in] Botswana, South Africa and Namibia, three main countries in supplying rough [diamonds], forces its owners of the sight [the fixed periodic quota of diamonds to be sold] to manufacture there, otherwise they will take the sight away from them,” says Schnitzer.

“That’s how manufacturing in Israel is declining. If there isn’t a serious production infrastructure here, then there will be no commercial center here either. The question is how to do it.”

The Diamond Center aims to revive polishing in Israel by taking the job of setting up new polishing operations from individual diamond dealers to the exchange itself. That means that small producers who could not afford to do this simply shut down.

In a pilot project, led by Yoram Dvash, the exchange’s treasurer, a new 2.5 million-shekel ($690,000) polishing facility will be outfitted with the most up-to-date machinery and employ some 100 people. Already 500 applicants have signed up to learn diamond polishing. The rent will be subsidized, the polishing stations ready and waiting, and the technology almost free. It is a sort of school to train dozens of workers every year, mainly recently released veterans, Haredim and women.

The plant will be located in a complex that once belonged to the Yerushalmi brothers diamond merchants. “We are planning on opening more schools, at least 10 within two to three years. We need to invest, and there are reserves in the Diamond Institute for it,” says Schnitzer.

Both the finance and economy ministries have expressed their support for the project.

“We are in negotiations over government funding for the months of training,” says Schnitzer. “They understand in the government that if we don’t increase production, the industry’s future is cloudy since the people in it are on average 50 years old.”

But the exchange wasn’t prepared to wait for state funding. “The industry needs to make up for lost time, so we couldn’t wait for approval from the Investment Center [in the Economy Ministry]. We have to step on the gas,” says Schnitzer.

Schnitzer estimates the number of diamond polishers at about 2,500 to 3,000. In addition, there are some 5,000 clerks, sorters and other workers in the industry. “I would like to reach 10,000 production workers,” says Schnitzer.

Eyal Toueg