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ICRA

THE INDIAN GEMS AND JEWELLERY SECTOR

July 2006

ICRA

SectorAnaly

sis

Indu

stry

Comment

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Copyright, ICRA Limited, 26 Kasturba Gandhi Marg, New Delhi - 110001

None of the information contained in this publication may be copied, otherwise reproduced, repackaged, furthertransmitted, disseminated, redistributed, or resold, or stored for subsequent use for any such purpose, in whole or inpart, in any form or manner or by means whatsoever, by any person without ICRA's prior written permission.

All information contained herein has been obtained by ICRA from sources believed by it to be accurate and reasonable.Although reasonable care has been taken to ensure that the information herein is true, such information is provided'as is' without any warranty of any kind, and ICRA in particular, makes no representation or warranty, express or implied,as to the accuracy, timeliness or completeness of any such information. All information contained herein must beconstrued solely as statements of opinion and ICRA shall not be liable for any losses incurred by users from any useof this publication or its contents.

In the course of work, ICRA may have received information from companies being rated or graded. However, thispublication does not contain any confidential information obtained by ICRA in the process of rating or grading. Thispublication contains data/information available only in the public domain or available through secondary sources.

Opinions expressed in this publication are not an indication of prospective rating/grading for any instruments to be issuedby any of the companies concerned.

Contacts :

Vineet Nigam Assistant General Manager

Amul Gogna Executive Director

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TABLE OF CONTENTS

ENVIRONMENT ANALYSIS-PORTER'S MODEL................................................................... 4

STRUCTURE OF THE INDUSTRY .......................................................................................... 5

OVERVIEW ........................................................................................................................................................... 5

IMPORTANCE TO ECONOMY............................................................................................................................ 5

GOLD .................................................................................................................................................................... 7

DIAMONDS ........................................................................................................................................................... 8

INDIAN JEWELLERY DEMAND ............................................................................................ 10

DOMESTIC GOLD JEWELLERY...................................................................................................................... 10

DOMESTIC DIAMOND JEWELLERY ............................................................................................................... 11

EXPORT MARKETS ............................................................................................................... 12

OVERVIEW ......................................................................................................................................................... 12

DOMINANT WORLD POSITION IN LOWER-SIZED CPD ............................................................................ 12

TRENDS IN INDIA'S SHARE OF CPD IMPORTS BY MAJOR MARKETS ............................................... 16

LOW, BUT RISING GOLD JEWELLERY EXPORTS ..................................................................................... 17

RAW MATERIALS ................................................................................................................... 18

OVERVIEW ......................................................................................................................................................... 18

DIAMONDS ......................................................................................................................................................... 20

KEY ISSUES FACING THE PLAYERS ................................................................................. 24

LARGE PRESENCE OF UNORGANISED SECTOR ..................................................................................... 24

RECENT INCREASE IN GOLD JEWELLERY CONSUMPTION................................................................... 25LIMITED POTENTIAL FOR GREATER VALUE ADDITION IN GOLD JEWELLERY .................................. 26

POSSIBLE LONG-TERM THREAT FROM CHINA ......................................................................................... 26

THREAT FROM POLISHING IN PRODUCING NATIONS ............................................................................. 27

CONTINUED SUPPORT FROM GOVERNMENT CRUCIAL ......................................................................... 27

TRENDS IN PRODUCTION, CONSUMPTION, PRICE, CAPACITY UTILISATION.......... 28

INDIA'S GJ EXPORTS ...................................................................................................................................... 28

INDIA'S GJ IMPORTS ....................................................................................................................................... 29

COMPONENT-WISE EXPORTS OF GJ .......................................................................................................... 29

COMPONENT-WISE IMPORTS OF GJ ........................................................................................................... 29

DESTINATION-WISE EXPORTS OF GJ ......................................................................................................... 30AVERAGE PRICE PER CARAT (P/C) OF ROUGH DIAMONDS IMPORTED INTO INDIA ...................... 30

AVERAGE PRICE PER CARAT (P/C) OF POLISHED DIAMONDS EXPORTED FROM INDIA .............. 30

DESTINATION-WISE EXPORTS OF CUT AND POLISHED DIAMONDS ................................................... 30

DESTINATION-WISE EXPORTS OF GOLD JEWELLERY ............................................................................ 30

DESTINATION-WISE EXPORTS OF COLOURED GEMSTONES ................................................................ 31

DEMAND SUPPLY POSITION ............................................................................................... 31

GOLD JEWELLERY ........................................................................................................................................... 31

DIAMOND JEWELLERY .................................................................................................................................... 31

REVIEW OF FINANCIAL PERFORMANCE ......................................................................... 32

OUTLOOK ................................................................................................................................ 35

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ENVIRONMENT ANALYSISPORTERS MODEL

Threat of Substitutes : Low

From historic times, gold has played a pivotal role inthe Indian social fabric. Gold is valued in India as asavings and investment vehicle and is the secondpreferred investment behind bank deposits. Gold isalso the preferred metal in jewellery. Domestic diamondjewellery demand is low, but increasing at a high ratebecause of higher incomes and aggressive marketingstrategies.

Bargaining Power ofSuppliers : Medium

With negligible domesticproduction of gold andgemstones, India relies largelyon imports. Bargaining powerof Indian industry enhanced bythe fact that India is the largestconsumer of gold. In roughdiamonds, the major globalsuppliers have very fewalternative customers (cuttingand polishing) for their cheaperrange of roughs.

Inter-Firm Rivalry : High

Bulk of the industry in India isconcentrated in theunorganised sector andemploys around 1.5 millionworkers serving over 0.2 milliongold jewellers and over 8,000diamond jewellers. The majorityof India's diamond workforce isemployed by small units, thatprocess diamonds on a job-lotbasis. However, the share ofthe unorganised sector hasdeclined in recent years.

Bargaining Power ofBuyers : Low to Medium

Bargaining power in gold jewellery limited to fabricationcharges. In diamond cuttingand polishing, the bargainingpower of Indian exportersarises from the fact that amajority of the world's roughdiamond production is cut andpolished in India.

Barriers to entry : Low

Low capital requirements, but skilled manpower isessential. Ability to invest in more advanced technologyis becoming increasingly critical.

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STRUCTURE OF THE INDUSTRY

Overview

The primary function of gems and jewellery (GJ) is to decorate and adorn. However, demand for different typesof GJ is influenced by several factors including buyer preferences, properties, varieties, unit values, application,etc. The GJ sector may be further categorised into the following sub-sectors based on characteristics, processingtechniques, preciousness in terms of price range and marketability.1. Gemstones

Diamonds Coloured Stones-precious, semi-precious, synthetic

2. Jewellery Plain gold Jewellery Studded Jewellery Silver Jewellery Costume Jewellery

3. Pearls

The two major segments of the GJ business in India are gold jewellery and diamond jewellery. While apredominant portion of gold jewellery manufactured in India is for domestic consumption, a predominant portionof rough, uncut diamonds processed in India in the form of either polished diamonds or finished diamond jewellery is exported. Preference for gold dominates the domestic jewellery demand. The domestic demand forgold jewellery is estimated at Rs. 390 billion in 2005, accounting for an estimated 80% of the Indian jewellerymarket of Rs. 490 billion. The balance comprises diamond jewellery (Rs. 80 billion), and other fabricated jewellery (Rs. 20 billion).

Importance to Economy

The GJ industry has an important role in the Indian economy. While a predominant portion of gold jewellerymanufactured in India is for domestic consumption, a predominant portion of rough, uncut diamonds processedin the form of either polished diamonds or finished diamond jewellery is exported. With an estimated consumptionof 722 tonnes during calendar year or CY2005 (including jewellery consumption of 587 tonnes), India is the largestconsumer of gold in the world. India is also estimated to hold nearly 14,000 tonnes of gold, accounting for nearly9% of the world's cumulative mine production. Apart from its historical religious significance, gold is valued as animportant savings and investment vehicle.

The GJ industry also contributes around 15% of India's exports. As the table below shows, exports of GJaggregated Rs. 688.30 billion (US$15.55 billion) during FY2006, accounting for 15.1% of India's exports. Ignoringminor year-on-year variations, the share of GJ in India's exports has grown over time from 4% in 1972-73.

India's GJ Exports and Imports

FY Exports- % of Imports- % of Trade Balance-billion total billion total billion

exports imports

Rs. US$ Rs. US$ Rs. US$1973 0.79 0.10 4.0% 0.42 0.05 2.2% 0.38 0.051995 141.31 4.50 17.1% 51.17 1.63 5.7% 90.14 2.871996 176.44 5.27 16.6% 70.45 2.11 5.7% 106.00 3.171997 168.72 4.75 14.2% 103.84 2.93 7.5% 64.88 1.831998 198.67 5.35 15.3% 124.21 3.34 8.1% 74.46 2.001999 249.45 5.93 17.8% 158.20 3.76 8.9% 91.25 2.172000 325.09 7.50 20.4% 235.56 5.44 10.9% 89.54 2.072001 337.33 7.38 16.6% 219.63 4.81 9.5% 117.70 2.582002 348.45 7.31 16.7% 220.45 4.62 9.0% 128.00 2.682003 437.01 9.03 17.1% 293.41 6.06 9.9% 143.68 2.972004 485.86 10.57 16.6% 327.57 7.13 9.1% 158.29 3.442005 618.34 13.76 16.5% 423.38 9.42 8.4% 194.96 4.34

2006 688.30 15.55 15.1% 404.69 914 6.4% 283.61 6.41Compiled by ICRA

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The bulk of the Indian GJ exports comprises import of rough diamonds, cutting and polishing in India, and re-export. As per data released by the Gems & Jewellery Export Promotion Council (GJEPC), cut & polisheddiamonds (CPDs) accounted for 71.1% of India's GJ exports of Rs. 733 billion during FY2006, followed by gold jewellery (23.2%), rough diamonds (3.4%), and others (2.3%). Thus, two items-CPDs and gold jewellery-account

for around 95% of India's GJ exports.

Component-wise Exports of GJ

Rs. Million US$ millionFY 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006

CPDs 283,465 342,979 395,506 500,736 521,198 5,972 7,111 8,627 11,182 11,860

Coloured Gemstones 8,665 9,256 8,181 8,639 10,289 183 192 178 193 233

Gold Jewellery 55,382 73,011 122,546 171,120 170,150 1,167 1,513 2,681 3,813 3,862

Pearls 126 210 188 122 105 3 4 4 3 2

Non Gold Jewellery 3,049 4,097 4,565 5,800 6,405 64 85 99 129 145

Synthetic Stones 114 53 53 49 28 2 1 1 1 1

Costume/Fashion Jewellery 483 460 470 10 10 10

Sales to Foreign Tourist 613 629 826 13 13 18

Rough Diamonds 6,730 11,619 24,507 15,994 24,868 142 241 536 358 565

Total Exports 3 58 ,6 26 4 42 ,3 13 5 56 ,8 40 7 02 ,4 60 7 33 ,0 43 7 ,5 56 9 ,1 70 1 2, 15 6 15 ,6 78 1 6, 66 9

With negligible production of gold and diamonds, the Indian GJ industry is almost entirely dependent onimported raw materials. During FY2006, imports of pearls, precious & semi-precious stones aggregated Rs.404.69 billion (US$9.42 billion), accounting for 11.2% of India's non-bulk imports, and 6.4% of total imports.

The Indian GJ industry is also a major earner of foreign exchange, with a trade surplus of Rs. 283.61 billion(US$6.41 billion) during FY2006, as compared with an overall trade deficit of Rs. 1,757.27 billion (US$39.69

billion). The GJ industry has contributed significantly to the shift in India's exports. They, alongwith chemicalsand allied products, engineering goods, ready-made garments, textile yarn, fabrics, made-ups have been themain drivers within the manufactured product exports during the last decade.

With the increase in exports in recent years, the GJ industry has also accounted for an increased share of grossbank credit (GBC) of scheduled commercial banks (SCBs). With GBC of Rs. 198.66 billion in March 2006, theindustry accounted for 3.61% of industry GBC of SCBs in March 2006, as compared with 2.7% in March 2000.

GBC to Gems and JewelleryAs of last Friday of March

Compiled by ICRA

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As shall be discussed below, India is the largest diamond cutting & polishing centre in the world, followed byIsrael. The bulk of the GJ industry in India is concentrated in the unorganised sector and employs an estimated2 million workers serving over 0.45 million goldsmiths, and around 0.1 million diamond processing units. Themajority of India's diamond workforce is employed by small units, that process diamonds on a job-lot basis. The

number of gold jewellery manufacturing units is put at 0.1 million. Also, a large number of skilled goldsmiths/gold merchants from India are engaged in gold trade and industry in almost all the oil-rich Middle Easterncountries.

Gold

Gold usually only occurs in a metallic state. It is commonly associated with sulphide minerals such as pyrite,but it does not form a separate sulphide mineral. Gold jewellery is usually manufactured using casting andmoulding techniques. Gold is found in a variety of environments globally, but generally requires grades inexcess of 1 gram/tonne (1 part per million) to be considered economic. Economic gold can be found in primaryore deposits as fine disseminations throughout the host rock or as concentrations caused by favourablechemical and structural environments. Weathering of these primary ores can produce secondary goldconcentrations, often as alluvial gold occurrences (often called `placer' gold).

Economic gold extraction can be achieved from ore grades as little as 0.5 gms/tonne (referred to as 0.5 partsper million or ppm) on average in large easily mined deposits. Grades vary enormously with ore bodies. Typicalore grades in open-pit mines are 1-5 gms/tonne; ore grades in underground or hard rock mines are usuallyat least 3 gms/tonne. Generally, the largest South African underground operations run at between 8-10 grams/tonne. At a grade of 10 grams/tonne, therefore, it takes more than 3 tonnes of ore to produce one ounce (oz.)or 31.1 gms. of gold. Many of the world's operations are open pits, which tend (generally) to be of lower gradethan the underground mines, running from 1 to 3 or 4 grams per tonne. The world's deepest gold mine iscurrently the Savuka mine on the North-West rim of the Witwatersrand Basin in South Africa. Some of Savuka'sminers are working at a depth of almost 4 kms, mining an ore grade which contains almost 20 cubic centimetresof gold in every cubic metre of rock, or 20 ppm. Production costs for gold mining vary widely, according to thenature of the mine (open pit or underground), depth of the mine, the nature and distribution of the ore-body(and by implication the metallurgy which affects processing techniques) and the grade. Average quoted cashcosts were estimated by Gold Field Mineral Services (GFMS) at US$269/troy ounce or oz.1 in 2004 (US$253/oz. in 2004), with total cash costs (including depreciation, amortisation, reclamation and mine closure costs) of

US$339/oz (US$313/oz.). By comparison, the average gold price increased US$35/oz. in 2005 to US$444.47/oz. These figures do not include greenfield exploration and other ancillary costs, which are estimated at aroundUS$30-40/oz., depending on the mining company concerned, to come to an estimate of true total costs.

The proportion of gold in jewellery is measured on the carat (or karat) scale. Pure gold is designated 24 carat,which compares with the `fineness' by which bar gold is defined.

Gold Caratage and Fineness

Caratage Fineness % Gold

24 1,000 100

22 916.7 91.67

18 750 7514 583.3 58.3

10 416.7 41.67

9 375 37.5

Source: World Gold Council (WGC)

In India (also in the Middle East and South East Asia), jewellery is traditionally 22 carat (sometimes even 23carat). The most widely used alloys for jewellery in Europe are 18 and 14 carat. While 14 carat gold jewellerydominates in the US, 9 carat is popular in Britain. In China, Hong Kong and some other parts of Asia, `chukkam'or pure gold jewellery of 990 fineness (almost 24 carat) is popular.

1 1 troy ounce or oz.= 31.1034807 grams; 0.375 oz=1 tola; 32,150 troy ounces =1 metric ton (1,000 kilos)

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Diamonds

Diamond is carbon in its most concentrated form. Except for trace impurities like boron and nitrogen, diamondis composed solely of carbon, the chemical element that is fundamental to all life. Diamond is the hardestsubstance known. Hardness is the measure of a substance's resistance to being scratched, and only a diamondcan scratch another diamond.

Diamonds are crystals made up entirely of carbon atoms that are arranged in an isometric, or cubic, matrix.However, most diamond crystals encounter varying heat or pressure, other elements, or even other diamondcrystals during their growth, and this can alter their form somewhat. The resulting form and characteristics ofthe crystal, once it emerges from the earth, help to determine what shape, color and clarity the polished gemwill have. The first known source of diamonds was India, but presently Australia, Botswana, Congo, Russia,Canada, and South Africa produce as much as 90-95% of the world's annual production diamonds. Diamondsare not easy to mine. Kimberlite, a plutonic igneous rock, ascends from a depth of at least 100 kilometers toform a diatreme (narrow cone-shaped rock body or "pipe"). Moreover, because much diamond is not of gemquality, the average stone in an engagement ring is the product of the removal and processing of 200 to 400million times its volume of rock. Most diamond-bearing ore bodies have a diamond content that ranges fromless than 1 carat per ton to about 6 carats per ton. For example, the Orapa Mine in Botswana produced 14.89

million carats in 2005 after treatment of 16.50 million tonnes of ore. The major gem diamond reserves are insouthern Africa, Australia, Canada, and Russia. The average grade of the richest diamond kimberlite pipes inAfrica is about 1 part diamond in 40 million parts ore. Production costs for kimberlites and lamproites can beas low as US$15 per tonne for large and easy-to-access diamond mines operating in good climatic conditionsand are up to about US$40-45 per tonne for small mines located in remote areas and operating under harshclimatic conditions.

A newly mined rough diamond looks somewhat like a piece of glass washed up on the beach than like thepolished gems sold in jewelry stores. Bringing out their beauty requires the skill and art of a trained diamondcutter. While incredibly precise, computerized machinery is now used in some parts of the cutting process forsome diamonds, most of the work is still performed by hand using exacting and meticulous techniques.

As a first step, cleaving or sawing is used to separate the original rough into smaller, more workable piecesthat eventually become an individual polished gem. Next, bruting grinds away the edges, providing the outline

shape (for example, heart, oval or round) for the gem. Faceting is then done in two steps: during blocking, thetable, culet, bezel and pavilion main facets are cut; afterward, the star, upper girdle and lower girdle facets areadded. Once the fully faceted diamond has been inspected and improved, it is boiled in hydrochloric and sulfuricacids to remove dust and oil. The diamond is then considered a finished, polished gem. Thus diamondprocessing is a 'highly skilled labour intensive' activity.

Diamond Features

Diamond DescriptionFeatures

Diameter Width of the diamond as measured through the girdleTable Large, flat top facet of a diamond

Crown Upper portion of a cut gemstone, above the girdleGirdle Narrow rim of a diamond that separates the crownfrom the pavilion. It has the largest diameter to anypart of the stone

Pavilion Lower portion of the diamond, sometimes referred toas the base

Culet Tiny facet on the pointed bottom of the pavilion,which is the portion of a cut gem below the girdle.

Depth The height of a gemstone, from the culet to the table.

Compiled by ICRA

Rough diamonds used for processing into cut and polished diamonds are generally broken down into threecategories: gems, near-gem, and industrials. Gem category represents the high end with high yield and value.

Near-gems are diamonds of poor quality that can be cut and polished but with a very poor yield. Industrialsare low-end quality used mainly for industrial applications. Around 10% of the world's annual diamond

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production is of gemstones which will be polished and set in diamond jewellery. An estimated 45% are near-gem qualities, which would have been graded as industrial 40 years ago, but are now polished by the vastlow-cost Indian cutting industry. The remaining balance is of industrial quality. During 2004, of the total diamondproduction of 156 million carats, an estimated 89.4 million carats were classified as gemstones. The balance

66.1 million carats were classified as industrial diamonds. Classifying diamonds into various categories is ahighly complex process and is done based on various factors including shape, colour and presence ofinclusions. Four characteristics, known informally as the four Cs, are now commonly used as the basicdescriptors of diamonds: these are carat, clarity, color, and cut. Most gem diamonds are traded on the wholesalemarket based on single values for each of the four Cs. Other characteristics not described by the four Cs caninfluence the value or appearance of a gem diamond. These include physical characteristics such as thepresence of fluorescence, data on a diamond's history including its source, and which gemological instituteperformed evaluation services on the diamond.

The carat weight measures the mass of a diamond. One carat is defined as exactly 200 milligrams (about 0.007ounce). The point unit-equal to one 0.01 carat or 2mg-is commonly used for diamonds of less than one carat.Individually, rough diamonds can range in size from micro-sized to stones weighing in excess of 1000 carat.A significant measure of a mine's production is the average size of its rough diamonds. Depending on the mine,the average size of rough diamonds recovered can vary from 0.01 carat (about 1 mm. in size) to more than

0.7 carat. Many mines in the world average about 0.4-0.5 carat per stone. The number of stones larger than1 carat (0.2 gms) produced at mines is very small (about 400 000 stones per year) and, in terms of total caratsproduced, this represents only about 0.5% of world production.

According to different sources, production costs (excluding depreciation and interest) for kimberlites andlamproites are approximately US$5-6 per tonne for large and easy-to-access diamond mines operating in goodclimatic conditions, and are up to about US$35-38 per tonne for small mines located in remote areas andoperating under harsh climatic conditions. The total production costs for these mines are around US$15 pertonne and US$40-45 per tonne respectively.

There are no international prices for diamonds such as there is for precious metals like gold, silver and platinum.The market prices for rough natural diamonds are almost constantly in a state of flux. All else being equal, thevalue of a diamond increases exponentially in relation to carat weight. Large diamonds are less commonly foundin nature, and more desirable for use as gemstones. The price also depends on carat weight, shape, clarityand colour. The prices vary widely, but the following is an indication of the prices paid at cutting and polishingfactories for gem-quality rough stones of 1 carat: US$20 for very low quality; US$200 for medium quality, US$400for good quality, and US$1,000 for the best quality. The Rapaport Diamond Report is the international trade pricelist for polished diamonds. It lists prices that are 'traded off' (usually at discounts) based on their shape, sizerange, color and clarity. The table below details the prices of comparable diamonds available for purchase inJune 2006.

Prices for Different Carats of Polished Diamonds

US$/carat, June 2006, Round cut, G color, VS2 diamonds with 1A cut grade

Carats Price Lowest

0.30-0.37 2,165 1,597

0.38-0.45 2,327 1,8110.46-0.49 2,331 2,109

0.50-0.69 2,963 2,330

0.70-0.89 3,702 2,987

0.90-0.99 4,948 3,978

1.00-1.49 6,213 4,883

1.50-1.99 8,615 6,250

2.00-2.99 12,348 8,499

3.00-3.99 16,875 15,399

4.00-4.99 20,577 20,286

Compiled by ICRA

The price per carat does not increase smoothly with increasing size. Instead, there are sharp jumps aroundmilestone carat weights, as demand is much higher for diamonds weighing just more than a milestone than

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for those weighing just less. As an example, a 0.95 carat diamond has a significantly lower price per carat thana comparable 1.05 carat diamond, due to differences in demand.

INDIAN JEWELLERY DEMANDDomestic Gold Jewellery

From historic times, gold has played a pivotal role in the Indian social fabric. Even in present times,gold remains the Indian bride's `Streedhan', the wealth she takes with her when she marries and whichremains hers. Gold jewellery is the preferred jewellery worn by women in India irrespective of theirreligious beliefs. In marriages, gold jewellery is the gift preferred by the near relatives of the bride andthe groom. Gold jewellery is very popular among farmers, with an upsurge in gold sales after a goodagricultural season. Buying of gold is an important part of every stage of an Indian citizen's life-at birth,marriage, construction of home, festivals, religious ceremonies, setting up of new business, and death.Apart from its religious and social significance, gold is valued as an important savings and investmentvehicle in India, and is the second preferred investment behind bank deposits.

Apart from its historical religious significance, gold circulates within the system and roughly 30% of gold jewelleryfabrication is from recycled pieces. With an estimated consumption of 722 tonnes during 2005 (including jewelleryconsumption of 587 tonnes), India is the largest consumer of gold in the world.

India's Gold Demandtonnes

Compiled by ICRA

India is also estimated to hold nearly 14,000 tonnes of gold, accounting for 9% of the world's cumulative mineproduction of around 153,000 tonnes. India is typically also the largest purchaser of coins and bars for investment.

World Gold Consumption for Jewellerytonnes

1998 1999 2000 2001 2002 2003 2004 2005 2006(Q1)

India 658 630 620 598 459 479 518 587 103US 350 374 387 389 386 348 351 349 60China 243 215 206 203 200 201 224 241 64Turkey 140 92 148 91 97 156 186 195 31Saudi Arabia 187 169 170 163 139 128 136 146 27UAE 63 81 94 95 88 84 89 96 26Italy 112 101 92 91 88 82 77 71 10Indonesia 42 110 87 98 93 82 84 78 16UK 64 65 75 82 79 73 70 59 8Egypt 135 138 128 116 82 66 73 75 13Others 1,190 1,180 1,225 1,111 979 847 810 814 177Total Jewellery Demand 3,183 3,154 3,232 3,038 2,689 2,547 2,618 2,712 535

India's share of world demand 20.7% 20.0% 19.2% 19.7% 17.1% 18.8% 19.8% 21.6% 19.3%

Compiled by ICRA

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India's gold jewellery demand is seasonal with the highest consumption during the festival and wedding season.

India's Quarterly Gold Demandtonnes

Compiled by ICRA

Domestic Diamond Jewellery

In the diamond business, Indian companies are mostly present at the `Beneficiate' level of the value chain wherethey are engaged in importing rough diamonds (or `roughs') from mining companies, cutting and polishingroughs, and exporting them for further consumption in jewellery, etc.

The Indian domestic diamond jewellery market is estimated at around Rs. 80 billion per annum in retail value.The demand for jewellery is dependent on India's gross domestic product's (GDP's) growth, which is expectedto be high in the near future. Although accurate and official data is not available, while China ranks sixth inthe world in terms of diamond jewelry retail value, ahead of India which is in seventh place, India ranks thirdin terms of diamond value, while China holds the seventh position. Because of increased disposable income

and aggressive promotion strategies by the diamond industry, Indian diamond jewellery demand has increasedsignificantly in recent years-from Rs. 19.7 billion in 1995 to around Rs. 80 billion in 2005. The diamond contentin the retail value has remained stable at around 71%. In 1992, a poll conducted by the Diamond TradingCorporation (DTC) examined the buying preferences of Indian women in its ideal target market, and discoveredthat only 10% of the women surveyed described diamonds as their preferred type of jewellery. By comparison,gold was preferred by 67% of the women surveyed. Since then, the situation has changed considerably, in partbecause of an industry-led consumer advertising campaign. A study similar to one carried out in 1992 wasconducted in 2002. The survey showed that 43% of the women in the same socio-economic groups identifieddiamonds jewellery as their first preference, compared with 34% for gold jewellery.

India's Diamond Jewellery Retail SalesRs. billion

Compiled by ICRA

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EXPORT MARKETS

Overview

The bulk of the Indian GJ exports comprises import of rough diamonds, cutting and polishing in India, and re-export. CPDs accounted for 71.1% of India's GJ exports during FY2006, followed by gold jewellery (23.2%),rough diamonds (3.4%), coloured gemstones (1.4%), and non-gold jewellery (0.9%). Thus, two items-CPDs andgold jewellery-account for around 96% of India's GJ exports.

Components of India's Exports of GJpercent

FY 2000 2001 2002 2003 2004 2005 2006

Cut & Polished Diamonds 81.6 79.5 79.0 77.5 71.0 71.3 71.1

Coloured Gemstones 2.5 2.6 2.4 2.1 1.5 1.2 1.4

Gold Jewellery 13.3 14.8 15.4 16.5 22.0 24.4 23.2

Pearls 0.0 0.0 0.0 0.0 0.0 0.0 0.0Non Gold Jewellery 0.6 0.7 0.9 0.9 0.8 0.8 0.9

Synthetic Stones 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Costume/Fashion Jewellery 0.1 0.1 0.1 0.1 0.1 0.0 0.0

Sales to Foreign Tourists 0.1 0.2 0.2 0.1 0.1 0.0 0.0

Rough Diamonds 1.7 2.0 1.9 2.6 4.4 2.3 3.4

Total 100 100 100 100 100 100 100

Value-Rs. billion 351.70 352.73 358.63 442.31 556.84 702.46 733.04

Compiled by ICRA

Dominant World Position in lower-sized CPDTraditionally, India has always excelled in the field of diamond and gem cutting, polishing and in the craft ofgold smithy. India's diamond tradition goes back thousands of years and is the oldest in the world. In fact,diamonds were discovered in India by the 8th century BC. In about 600 AD, diamonds were found inKalamantian, Borneo and are still mined there. Except for a minor supply of diamonds from the Kalamantiandeposits of Borneo, dating from the 6th century AD, India was the world's only source of diamonds until the1730s. Most of India's deposits were alluvial, but today the Majhgawan pipe, a primary source near Panna, isthe country's only producing diamond source. In addition to the diamond legends, India yielded many legendarydiamonds, including the Koh-i-Noor, the Orlov, the Hope, and the Sancy. Important sources of diamondsdiscovered in Brazil in 1725, and in South Africa in 1867 marked a dramatic increase in the world diamondsupply. India's maximum production, around 100,000 carats annually in the 16th century, is small by modernstandards (150 million carats during 2004). When diamonds were discovered in Brazil in 1725, Indian diamondsources were near exhaustion. From 1730 to 1870, Brazil was the world's major source of diamonds. In 1867,

the discovery of diamonds in the Cape Colony, now a province in South Africa, modified not only the world'ssupply of diamonds but also its conception of them. Annual world diamond production increased more thantenfold in the following 10 years. Over the next 15 years, South Africa yielded more diamonds than India hadin over 2,000 years. This increased production of diamonds coincided with the depletion of Brazilian depositsand with a great rise in demand, particularly in the US. In the 1870s and 1880s, Kimberley, encompassing themines that produced 95% of the world's diamonds, was home to great wealth and rivalries, most notablybetween Cecil Rhodes and Barney Barnato, two English immigrants who consolidated their early 31-foot-squareprospects into ever larger holdings and mining companies. In 1888, Rhodes formed De Beers ConsolidatedMines Ltd., a company that still dominates the world production of diamonds. In 1889, Barnato sold hiscompanies to Rhodes for 5.34 million, paid for with the largest cheque ever issued at that time.

Indian craftsmen were the first to unlock the secrets of diamond cutting, although the cutting did not includefaceting and polishing as is common today. Most Indian diamonds were flat-cuts. They were also almost all verylarge stones because the mines at Golconda, Andhra Pradesh were hand-dug. The Golconda mines were

exhausted in the 19th century, just about the time alluvial diamonds were found in Brazil. By the end of the 19thcentury, the great Indian diamond era had passed into history.

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However, the beginning from the 1960s, another industry took roots-the Indian diamond-processing industry. TheIndian diamond processing industry was largely created when the world demand and prices of industrialdiamonds had declined during the 1960s, because of the advances of synthetic industrial materials. It was thendiscovered that some industrial diamonds could be processed using cheap labour, and the resultant polished

diamonds be applied to jewellery. Thus the term `near-gem' or `Indian goods' was invented. As compared withthe traditional diamond cutting & polishing centres of Belgium; India, with its low labour cost, opened up newpossibilities for the world diamond industry. This was because, inexpensive stones, in which the cost ofprocessing would be a significant component of the selling price, could now be processed. As a result, diamondscould be made affordable for new, less affluent buyers.

As a result, India captured an increased proportion of this market, and at present, India is the world's leadingdiamond cutting and polishing centre. In recent times, India has increasingly held a dominant position in theworld in the cutting and polishing of diamonds. At present, India is the world's leading diamond cutting andpolishing centre, accounting for accounting for 55% share of the global polished diamond market in terms ofvalue, 80% share in terms of caratage, and 95% share in terms of pieces in the global production of cut andpolished diamonds. While diamonds are cut, polished and processed in nearly 30 countries, India, Israel,Belgium, and the US dominate the diamond cutting and manufacturing industry globally. Other aggressivelyemerging centres include North Western Territories of Canada, China and Thailand. While Belgium and Israel

dominate the cutting and polishing of larger-sized and larger-value diamonds (over 0.5 carats) 2, India dominatesthe lower-sized, lower-value market (less than 0.5 carats). For example, the p/c (p/c) realisation of Indian exportsof CPD was US$274 during FY2006, as compared with US$1,493 for Israel, and US$949 for Belgium. Theaverage size of the Indian CPD production is estimated at 0.02 carats per stone. Thus, India was estimated tohave exported around 2.2 billion CPDs during FY2006.

India also continues to be the leading centre in terms of value added. Value added is defined as the value ofpolished produced from local manufacturing less the cost of rough used to produce it.

Value of Polished Output by Cutting Centres in 2005

Compiled by ICRA

Because of its international competitiveness arising out of low-cost and skilled diamond processing, India is theworld's leading centre for CPD. As the table below indicates, India accounted for 25% of the total world exportsof CPDs during 2004. Further, India's share has increased from 21.3% in 1997.

2 The majority of diamond cutters in Belgium are employed in the better quality, larger caratage segment, because high labour

costs make it uneconomic to process the smaller sizes. The majority of polishing in Israel is geared towards polished diamondsabove 0.15 carats. However, some small, better quality polished diamonds are still manufactured in Israel.

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Major World Exporters of Diamonds (Jewellery) worked but not mounted or setUS$ million

2000 2001 2002 2003 2004

Belgium 6,063 5,956 6,470 4,848 5,554

China 468 515 637 838 1,171

Hong Kong 1,462 1,324 1,628 1,935 2,414

India 6,270 5,957 7,350 8,139 10,050

Israel 7,841 7,391 8,347 8,889 10,574

Switzerland 509 418 468 468 808

UK 539 591 710 786 901

US 3,846 3,897 4,399 5,006 6,599

Others 1,436 1,446 1,459 1,885 1,899

Total 28,433 27,495 31,468 32,793 39,969

Compiled by ICRA from UN Comtrade Data

Apart from dominating the smaller-sized segment, India has been consolidating its position in the larger-sizesegment, resulting in higher export values but lower export volumes. For example, while exports of CPD involume terms declined from 47.9 million carats in FY2005 to 43.3 million carats in FY2006, export valueincreased from US$11.18 billion to US$11.86 billion.

India's dominance in CPDs is attested by the fact that during 2005, India imported more carats than all the minestogether produced, mainly because of offloading of inventories. During FY2006, India imported 173 millioncarats of rough diamonds, valued at US$8.71 billion-at an average value of US$50.3 p/c. However, exportsaggregated 43.27 million carats, valued at US$11.86 billion, at an average price of US$274.1 p/c. This significantlower caratage and higher value is mostly a result of the lower production yield in the cheaper lower-size stones,where sometimes more than 80% of the material can be lost in the cutting process. The rough diamondsprocessed in India are overwhelmingly smaller-sized which cannot be shaped to intricate designs by theautomatic machines used by other leading diamond processing countries, such as Israel and Belgium, whichdeal with much larger sizes. Most of India's diamond merchants are based in Mumbai, with nearly 1,400 outof 1,500 active diamond exporters.

The diamond industry pipeline below demonstrates how annually US$13.2 billion of rough diamond mine salesduring 2005 was transformed into US$62.5 billion of global diamond jewellery sales. The pipeline shows thevalue chain from producers of rough diamonds through the traders and manufacturers of the polished stonesto the jewellery manufacturers and retailers.

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Diamond Industry Pipeline-2005US$ billion

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Trends in India's Share of CPD Imports by Major Markets

US

Trends in the world's largest diamond jewellery market, the US, highlight the growing presence of India in the

cutting and polishing of lower-sized diamonds. Although the US accounts for less than 1% of the world diamondproduction, it is the largest gemstone and diamond market in the world, accounting for 51% of world retaildiamond jewellery sales of US$62.5 billion in 2005. Polls conducted by US jewellery retailers' associationsindicate that around two-thirds of domestic consumers designate diamond as their favourite gemstone. After adecline in 2001 following the economic slowdown of the first half of 2001 and the economic effects of the terroristattacks, US diamond sales recovered to US$27.2 billion in 2002, and to US$32 billion in 2005. After a 10.8%decline in imports of CPD into the US during 2001 (caused by the terrorist attacks), imports of CPD into theUS have increased during 2002-05. The average price also increased from US$619.2 p/c in 2001 to US$907in 2005.

There is a two-tier market in the US: a potentially growing market of diamond jewellery with little or no diamondvalue, and a market of expensive goods with diamond values of US$1,000 and more. During 2005, Israelsupplied 52.7% of all imports of CPD by value into the US, followed by India (20%), and Belgium (18.3%).However, India's market share has marginally declined from 22.9% during 2002, mainly because of a shift in

the US market towards higher-sized diamonds. The reduced market share for India is also because of lowermarket share in the lower-priced diamonds. The market share loss was to Israel.

As the table below indicates, while Israel dominates the US market for larger-sizes with a market share of 60.3%in value terms during 2005, India controlled 68.6% of the US market for lower-sizes. India's overall market sharein value terms increased from 22.9% during 2002 to 20% during 2005. The reduced market share of India isreflective of the shift in the US market during recent years, with a shift in the price ranges of retail jewellerypurchases from the under US$500 price range to the US$500-2,000 price range, caused by economic growth.Significantly, while India's market share in small-sizes increased from 62.9% in 2001 to 68.6% in 2005, its shareof large-sizes increased from 5.3% in 2001 to 9.9% in 2005, and to 10.7% in January-April 2006. The increasedmarket share in larger-sizes, alongwith dominant position in lower sizes, has resulted in an increase in p/crealisation of Indian exports to the US-from US$197.5 in 2001 to US$304.3 in 2005. Though in terms of overallvalue India is still a small player when compared with the traditional centres, the rate of growth is increasinglysignificant. This implies that apart from dominating the smaller-sized segment, India has been consolidating its

position in the larger-size segment.US Imports of CPD

Value Volume(US$ million) (thousand carats)

2003 2004 2005 2006(4M) 2003 2004 2005 2006(4M)

UNDER 0.5 CARAT 2,705 2,669 2,651 927 13,356 12,204 11,020 4,023Belgium 282 275 197 64 775 786 530 145China 6 10 13 4 73 67 79 19Hong Kong 59 43 58 43 374 200 228 254India 1,749 1,769 1,817 611 10,509 9,719 8,780 3,006Israel 525 477 425 141 1,045 969 843 285Others 84 95 140 65 580 463 559 313

OVER 0.5 CARAT 9,456 11,203 12,724 4,301 5,759 6,189 5,977 1,864Belgium 2,310 2,451 2,623 778 1,263 1,229 1,161 362China 6 13 29 13 5 5 12 6Hong Kong 124 111 162 50 77 71 83 17India 815 1,083 1,262 460 1,211 1,526 1,340 432Israel 5,544 6,655 7,672 2,578 3,002 3,084 3,069 937Others 658 889 976 422 201 275 313 110Total 12,161 13,872 15,375 5,228 19,116 18,393 16,997 5,887Belgium 2,592 2,726 2,820 842 2,038 2,015 1,691 508China 12 23 41 16 78 72 91 25Hong Kong 183 154 220 93 451 271 311 270India 2,564 2,852 3,080 1,071 11,720 11,245 10,120 3,438Israel 6,069 7,132 8,097 2,719 4,047 4,053 3,912 1,223Others 742 984 1,116 487 781 738 872 423

Compiled by ICRA

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Japan

In the Japanese market for retail diamond jewellery sales of US$9.8 billion during 2005, India's share of Japan'sCPD imports has increased in value terms from 37.2% in 2001 to 42.1% in 2005, mainly at the expense of Israel.Over the same period, the share of imports from Israel declined from 26% to 13.8%. Indian exporters have also

achieved higher p/c realisations-from US$198.2 in 2001 to US$255.8 in 2005.

Polished diamond imports into Japan

Value-US$ million Volume-thousand carats2002 2003 2004 2005 2002 2003 2004 2005

Belgium 186 233 273 237 226 279 276 265

China 4 8 8 16

Hong Kong 46 45 63 66 198 159 173 143

India 376 390 521 442 1,873 1,805 1,920 1,729

Israel 233 177 186 145 198 175 155 133

Thailand 23 22 32 32

US 36 39 42 47 57 61 40 42

Others 38 55 90 105 36 41 94 124

Total 937 965 1,176 1,052 2,619 2,561 2,658 2,452

Compiled by ICRA

Low, but Rising Gold Jewellery Exports

With various government initiatives in recent years, export of gold jewellery has also increased in recent years-exports increased 42.2% during FY2005 to US$3.81 billion, as compared with growth of 77.2% during FY2004.However, exports increased only 1.3% during FY2006, mainly because of lower exports to UAE. India's exportsof gold jewellery have increased in recent years because of healthy growth in demand in key markets, andintensive efforts by exporters towards improved quality and new designs. Gold jewellers have identified exports

as a focus area, setting up manufacturing units and design training centres to improve quality. The industry isalso promoting Indian ornaments in the US, Hong Kong, and the Middle East. For example, India's exports ofarticles of jewellery (ITC HS: 7113) to the US has increased from US$565 million in 2001 to US$1,751 millionin 2005. India has thus displaced Italy as the largest exporter of articles of jewellery to the US.

India's Exports of Articles of Jewellery to the US

Compiled by ICRA

One of the major reasons why India has not made a significant impact in jewellery exports market is the

existence of government restrictions on the domestic jewellery industry in the pre-economic liberalisation era.The price of gold in India in the pre-liberalisation era was kept artificially higher than the world price to dissuade

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people from hoarding gold. Therefore, a gold smuggling industry flourished. If gold jewellery exports were tobe encouraged, it would be necessary to allow bulk imports of gold which, would have to be converted to jewellery and then exported. But allowing bulk imports of gold was considered risky as it was felt that such goldcould find its way into the retail market and sold at the higher prices prevailing in India. The situation changed

when the economic liberalisation of India started in 1991. Gold prices in India are now at a par with world prices,so gold smuggling has been curbed. Bulk imports of gold are now feasible and do not pose the kind of riskthat existed before 1991. The prospects for increase in exports of gold jewellery and diamond-studded gold jewellery have increased considerably.

RAW MATERIALS

Overview

With negligible domestic production of gold, diamonds, and other gemstones, India has to import almost itsentire requirements. The Indian GJ depends entirely on imported raw materials. Over the last several years,imports of pearls, precious & semi-precious stones have accounted for 8-10% of India's total imports. Anestimated 67% of India's GJ imports during FY2006 were of rough diamonds (which are then cut & polished

for re-export), followed by CPDs (23%), and gold bars (6.6%).

Components of India's Imports of GJPercent

FY 2000 2001 2002 2003 2004 2005 2006

Rough Diamonds 82.8 80.5 78.8 81.4 76.4 65.7 67.0

Rough Coloured Gemstones 1.5 1.8 1.2 0.9 0.8 0.7 0.8

Raw Pearls 0.1 0.1 0.1 0.1 0.0 0.0 0.0

Rough Synthetic Stones 0.0 0.0 0.0 0.0 0.0 0.0 0.1

Gold Bars 7.5 9.2 10.8 8.7 8.7 7.4 6.6

Silver Bars 0.1 0.2 0.1 0.3 0.2 0.2 0.2Platinum Bars 0.2 0.1 0.2 0.0 0.0 0.1 0.0

Cut and polished diamonds 7.7 8.1 8.7 8.2 12.7 24.4 23.0

Others 0.1 0.1 0.2 0.5 1.1 1.4 2.2

Total Imports 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Value-Rs. billion 252.78 246.34 255.07 374.87 432.82 526.00 576.99

Compiled by ICRA

Gold

India's production of gold was estimated at 3.05 tonnes during FY2006, as compared with 3.53 tonnes duringFY2005. By comparison, total gold demand was estimated at 745 tonnes in 2005.

Gold Production in India

FY 2000 2001 2002 2003 2004 2005 2006

Quantity-kgs 2,586 2,615 2,810 3,153 3,363 3,526 3,048

Value-Rs. million 1,558 1,235 1,281 1,659 1,815 2,145 1,891

Compiled by ICRA

After cessation of economic operations in Bharat Gold Mines Limited since 2000, Hutti Gold Mines Limited (aGovernment of Karnataka undertaking), is the only undertaking engaged in the mining of gold in India. However,gold is also recovered as by-product by Hindustan Copper Limited and Indo Gulf Corporation Limited. The total

recoverable reserves of gold in the country as on April 2000 were estimated at 19.75 million tonnes, 88 tonnesof gold metal.

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To meet its consumption requirements for jewellery and investments, India imported an estimated 443 tonnesof gold during 6MFY2006 (the latest period for which detailed data is available), valued at Rs. 271 billion.Average price per 10 grams increased from Rs. 3,907 in FY2004 to Rs. 6,115 in 6MFY2006. The major suppliercountries to India include Switzerland, South Africa, Australia, Hong Kong, and UAE.

India's Gold ImportsRs. Million

FY 2000 2001 2002 2003 2004 2005 2006(6M)

Australia 880 232 3,896 7,497 58,643 78,303 51,099

Hong Kong 65 59 380 997 11,745 5,968 669

South Africa 58,987 27,301 47,946 82,728 69,487 71,691 37,391

Switzerland 93,238 123,715 115,864 75,630 108,899 220,808 143,309

UAE 2,677 1,445 11,331 9,091 37,505 77,446 28,611

UK 22,850 35,611 14,296 6,843 7,201 3,182 5,092

Others 1,310 2,079 5,183 3,291 5,984 7,562 4,637Total 180,007 190,443 198,897 186,077 299,462 464,962 270,809

US$ million 4,154 4,169 4,170 3,845 6,517 10,348 6,204

Tonnes 471.58 471.21 471.40 606.67 766.60 768.88 442.87

Rs. per gm. 381.7 404.2 421.9 306.7 390.6 604.7 611.5

Compiled by ICRA

Gold is produced from mines on every continent with the exception of Antarctica (where mining is not permitted.World gold mine production increased around 1.3% during 2005 to 2,494 tonnes, as compared with a declineof around 5% during 2004. According to its review of world gold supply and demand, GFMS estimated thatinspite of reports of mine closures, operational difficulties and lower grades in several of the world's key gold

producing regions, global gold output increased during 2005.

World Gold Productiontonnes

CY 1999 2000 2001 2002 2003 2004 2005

South Africa 450 428 394 395 376 341 300

Australia 300 296 285 266 284 259 254

United States 342 355 335 299 285 258 250

China 163 172 193 202 213 215 225

Peru 128 133 134 157 172 173 175

Russia 138 154 165 181 182 169 165

Canada 158 155 157 148 141 129 115

Indonesia 152 140 183 158 163 93 140

Others 744 757 775 784 778 826 870

Total 2,574 2,591 2,621 2,590 2,593 2,463 2,494

Compiled by ICRA

The dominant gold producing country for much of the 20th century was South Africa, which was producing 1,000tonnes per annum in the early-1970s, or over 70% of the world total at that time. However, over the past twodecades, while South African production has dropped to 300 tonnes in 2005 (due to ageing mines; and continuedrise in costs at South African gold mines, owing to the strengthening of the rand causing several mines to curtailexpansion operations and reduce gold production). However, other nations (especially China, Peru and Indonesia)

have expanded their output considerably. The most spectacular rises in output over the past decade have comefrom Indonesia, where production increased from 2 tonnes in 1992 to 140 tonnes in 2005; and from

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Peru, where production has risen from 18 tonnes in 1992 to 175 tonnes in 2005. Gold production in Indonesiahas risen primarily from the Grasberg mine, which is the world's largest gold-producing mine, and from a joint-venture copper-gold deposit held by Rio Tinto and Freeport McMoran Copper & Gold Inc. In Peru, almost halfof production comes from Newmont's Yanacocha mine, the second largest gold mine in the world.

World gold mine production is expected to increase 4% in 2006 to around 2,600 tonnes because ofproduction increases in South America, Australia and the US. However, output in Indonesia at theGrasberg mine is expected to decline by 34 tonnes. A number of new mines in US and South Americawill also ramp up to full production in 2006. Over the medium-term, world mine production is expectedto increase modestly over the outlook period. Low gold prices in the late 1990s led to a reductionin expenditure on global gold exploration and a substantial fall in major gold discoveries. Despitethe recent increase in global gold prices encouraging a substantial increase in gold exploration,there is a limited number of large projects due to commence in the medium term.

The WGC calculated that the total global supply of gold in 2005 was 3,860 tonnes, representing an increaseof 15.5% over 2004. There was a 1.3% increase in mine production; 40.8% increase in official sector sales; and0.8% increase in old gold scrap sales. On the demand side, jewellery fabrication demand increased 3.8% during2005 because of higher demand in India. In value terms, jewellery demand worldwide increased 12.7% during

2005 (18.8% during 2004) to US$38.75 billion. While industrial and dental demand increased 2.4%, net retailinvestment increased 13.8% to 387 tonnes. However, demand from Exchange Traded Funds and similarproducts (ETFs) increased 56.4%.

World Gold Supply and DemandTonnes

Supply 2003 2004 2005 Demand 2003 2004 2005

Mine Production 2,593 2,463 2,494 Jewellery Fabrication 2,477 2,613 2,712

Net Producer hedging -270 -427 -138 Net retail investment 381 410 420

Official Sector Sales 617 471 663 Industrial & dental 293 340 387

Old Gold Scrap 939 834 841 ETF and similar 39 133 208

Total 3,879 3,341 3,860 Total 3,190 3,496 3,727

Source: WGC

During 2006, on the supply side, while mine production is expected to increase by 90 tonnes, official sectorsales could decline to around 500-550 tonnes. While signatories to the Central Bank Gold Agreement areexpected to sell the majority of the 500 tonnes allowed under the second year of the agreement, purchasesof gold by central banks that are not signatories to this agreement are expected to increase moderately. Oldgold scrap supply could also increase because of sustained rise in gold prices. On the demand side, rising goldprices could dampen jewellery fabrication demand in India and other price-sensitive markets. However, asubstantial rise in export earnings from oil is expected to encourage further growth in jewellery demand in theMiddle-East. Investment demand should be sustained because of increased institutional investment into gold.Recent months have seen rising interest in gold such as pension funds. Producer's de-hedging's contribution

to demand is expected to increase to 200-300 tonnes in 2006, as compared with 138 tonnes in 2005.

Identified world gold resources at end-2004 were estimated to be 100,000 tonnes, of which 15-20% were by-product resources. South Africa had about 50% of the world resources, followed by the US. Except for gold lostor used in dissipative industrial uses, all the gold ever mined still exists. About 15% of all gold ever mined isestimated to have been used in dissipative industrial uses or is either unaccounted for or unrecoverable. Ofthe estimated 155,000 tons of all gold ever mined till end-2005, about 22,000 tonnes is thought to have beenlost, used in dissipative industrial uses, or otherwise was unrecoverable or unaccounted for. Of the remaining132,000 tons, central banks hold an estimated 28,000 tons as official stocks, around 25,000 tonnes is held asprivate investment, and the balance 80,000 tonnes as jewellery.

Diamonds

As compared with India's imports of 173 million carats of rough diamonds during FY2006, India's diamond

reserves are estimated at around 1 million carats. Total production of diamonds in India has declined from81,436 carats during FY2002 to 60,155 carats during FY2006.

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India's Diamond Production

FY 2000 2001 2002 2003 2004 2005 2006

Quantity-carats 40,956 57,407 81,436 84,407 71,259 78,315 60,155

Value-Rs. million 214 301 396 396 318 376 313

Compiled by ICRA

World production of diamonds (gemstones and industrial) was estimated at around 175 million carats during2005, valued at US$12.7 billion. Around 20% of this volume are gems, which will be polished and set intodiamond jewellery and 45% are near-gem qualities, which would have been graded as industrial 40 years agobut are now polished by the vast low-cost Indian cutting industry. The balance is of industrial quality. Althoughmore than 90% of the industrial diamonds are produced synthetically, there are still some preferred uses ofnatural stones.

Russia, Botswana and South Africa are the world's major gem quality diamond producers, with Australia beinga major industrial diamond producer. Till 2003, Australia was the world's largest producer of diamonds by

volume, and a major supplier of roughs to Indian diamond merchants. The Argyle mine (wholly-owned by RioTinto) was the world's largest producer by volume; however the present open pit mine is expected to reach theend of its life in 2008. Argyle's production declined from 30.9 million carats in 2003 to 20.62 million in 2004.However, Argyle's production increased to 30.48 million carats in 2005. In a positive development for India'sCPD industry, Rio Tinto has announced it will develop a US$760 million underground project at its Argylediamond mine in the Kimberley region of Western Australia and thus extend the life of the mine to 2018. In orderto enable Argyle to guarantee its clients a continuity in diamond supplies in the interim period between thebuilding of the underground operation and the cessation of open pit mining in 2008, Rio Tinto has indicatedthat it will spend an additional US$150 million on a related open pit cutback and thus, de facto, extend the lifeof the present open pit operations. The average annual production over the life of the underground mine from2007 to 2018 is expected be around 60% of Argyle's historical annual average of 34 million carats and of similarquality. Most of Argyle's annual output is small and of low quality. Although most of the annual output is smalland of low quality, the mine is also famous for its very valuable pink stones, which the company polishes andsells annually by worldwide tender. The pink diamonds in each tender have an average size of about 1 carat

and around 40 to 50 carats in total are sold at these auctions each year. Prices achieved are typically in excessof US$100,000 per carat.

World Diamond Productionthousand carats

1999 2000 2001 2002 2003 2004 2005

Angola 3,733 4,311 5,156 5,022 5,000 6,000 6,900

Australia 29,784 26,568 26,176 33,642 33,100 20,580 43,300

Botswana 22,930 24,660 26,400 28,400 30,400 31,100 30,500

Canada 2,429 2,534 3,716 4,937 11,200 12,600 11,700

Congo (Kinshasa) 20,120 17,700 18,200 21,856 27,000 28,000 28,000Russia 23,000 29,200 29,200 29,000 33,000 35,600 31,800

South Africa 10,010 10,790 11,170 10,880 12,670 14,480 15,000

Others 5,994 6,237 6,982 6,263 6,630 8,040 7,800

Total Volume 118,000 122,000 127,000 140,000 159,000 156,400 175,000

Compiled by ICRA

Botswana is the world's largest diamond-producing country in terms of value, estimated at US$3.3 billion in2005. The four operating mines-Jwaneng, Orapa, Letlhakane, and Damtshaa-are owned by Debswana, a jointventure between De Beers and the Botswana Government. With production of 16.07 million carats in 2004, theOrapa mine in Botswana is now amongst the largest diamond mine in the world. The recoverable ore grade

at the mine is about 0.95 carats (190 mg) per ton.

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Russia is the second largest producer of diamonds in the world by value. All the five Russian mines are situatedin the Western Yakutia, and are owned by the state company Alrosa. Alrosa is the world's second largest diamondmining company by diamond production. In Russia, half of the rough output is presently sold for polishing andhalf is exported. Of this, most is sold to the DTC through a five-year agreement signed in 2001, which was till

recently pending approval from the European Union (EU). Recently, the EU has accepted De Beers's commitmentto reduce the quantity of Alrosa's rough diamonds that De Beers may purchase until the end of 2008, and to stoppurchasing Alrosa's rough diamonds, directly or indirectly, from 2009 onwards. De Beers purchased US$868million worth of Alrosa diamonds in 2001, which however declined to US$635 million in 2003. For many years,the exact figures on diamond production were `guess-estimates', as carat production figures were considered astate secret. Some of these figures have been declassified and in 2003, Alrosa produced 33.02 million carats ofrough diamonds, which were sold for an average price of US$51 p/c aggregating US$1.7 billion. Alrosa's totalproduction for 2004 was estimated at 31.71 million carats, valued at US$62.71 p/c for a total of US$1.99 billion.Of this, an estimated US$700 million was marketed through the DTC.

World Diamond Production Value in 2005US$ billion

De Beers is the largest diamond miner in the world. Its mines in Botswana, South Africa, Namibia and Tanzania

produced 28% by caratage (49 million carats) of the world's diamond production in 2005. The De Beers Groupproduction, inclusive of joint ventures in Namibia and Botswana, increased 4% in 2005 to 49 million carats.During 2005, the company's marketing arm-the Diamond Trading Company (DTC)-raised its rough diamondprices on two occasions, the cumulative effect of which was that sales by the DTC in 2005 were at prices, onaverage, 9.5% higher than in 2004. DTC sold 48% of world total production in 2003, which represents a steepfall from the recent past when (in 2000), the company's market share was about 60%, and the 1970s and 1980swhen it was 80%. During 2004, the total mining sales of DTC and the market were about US$11.388 billion.The total rough supply to the markets was estimated at US$11.9 billion. Of this, DTC's supply was US$5.695billion, or 48% of total rough supplies. There was strong demand for rough diamonds from the cutting centresthroughout 2004, and sales by DTC increased 14.8% during 2005 to US$6.5 billion.

Because of increased exports of CPD in recent years, India's imports of uncut diamonds have increasedsignificantly in recent years. During FY2005, India imported 176 million carats of rough diamonds valued at roughlyUS$7.60 billion (Rs. 342.42 billion). The major supplier countries include Belgium, UK, Israel, UAE, and US.

India's Diamond ImportsRs. million

Country FY2000 FY2001 FY2002 FY2003 FY2004 FY2005

Belgium 137,726 115,586 116,607 171,893 181,677 195,062Australia 42,756 51,427 49,786 71,645 78,756 78,369Israel 18,001 14,169 11,508 18,804 22,308 26,342UAE 2,140 7,677 8,188 14,933 17,204 9,681UK 12,691 14,807 18,552 25,874 18,404 17,420Others 1,753 1,794 3,078 1,892 12,292 15,547Total Imports 215,066 205,461 207,719 305,042 330,640 342,420US$ Million 4,947 4,507 4,348 6,271 7,141 7,595

US$ per carat 37.0 44.9 33.6 30.1 35.9 43.1Compiled by ICRA

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Maintaining an uninterrupted supply of rough diamonds is critical to the Indian GJ industry, which obtains itsrequirement from De Beers, South Africa, and the Antwerp Diamond Market in Belgium. Diamonds fromAustralia's Argyle mine, which are almost entirely processed in India, come through the Argyle sales office inAntwerp. Between 1983 and 1996, most of the Argyle rough diamonds were marketed through sales agreements

with De Beers. In 1996, the company began to market its entire production of diamonds through its Antwerpoffice. The majority of Argyle's customers are Indian based companies. Many in the Indian industry also buyrough diamonds from the Hindustan Diamond Company (HDC), a joint venture between the GoI and the Bankof Bermuda, in which De Beers has an equity stake3.

Most world diamond supplies are controlled by a few major mining companies; prices are supported bymanaging the quantity and quality of the gemstones relative to demand, a function dominated by De Beers,South Africa through DTC. From the early 20th century, the world diamond trade has been dominated by DeBeers. However, its share of total rough supplies has declined to 48% in 2004. As recently as 2001, its marketshare was 60%. With the exception of Alrosa, which sells part of its output through DTC in 2004, all otherproducers now sell their own output directly to the market.

The DTC holds an estimated ten week-long selling sessions called 'sights' each year. These sights are byinvitation only, and only a handful of potential buyers from around the world (called 'sightholders') are allowed

to attend. De Beers presently sells to an exclusive group of about 92 sightholders, including around 37 Indiansightholders, who are traders or cutters located in diamond cutting centres around the world. All sightholdersare required to meet DTC's criteria under its `Supplier of Choice' (SoC) strategy (SoC). Launched in 2000, SoChas been designed to promote consumer demand for diamonds in the face of greater competition from otherluxury goods. A critical element of this relates to the sightholder's ability to add value and to help grow consumerdemand. These sightholders can expect to reap significant benefits from De Beers', including a consistent supplyof rough diamonds, marketing support, and access to the DTC's consumer research knowledge base. Thesightholders do not know in advance how many stones they will be told to buy or what the assortment willinclude. Sightholders who do not like the system may not be invited again. The sightholders may chose to cutthe rough diamonds they buy themselves, or they may chose to sell some of the rough diamonds to smallermanufacturers. These smaller manufacturers cut the rough diamonds and sell the polished gems either to jewellery manufacturers (who set the diamonds into finished pieces of jewellery and then sell the jewellery to jewellery retailers), or to diamond wholesalers (who then, in turn, sell the diamonds to diamond retailers). Inthe less common route from mine to market, some independent miners elect not to sell their mine productionto De Beers. Instead, they offer newly mined diamonds directly to other world buyers. These buyers, in turn, maychose to cut and sell the diamonds themselves, or pass the diamonds along within the industry. De Beers islikely to continue dominating the rough diamond distribution and sales in the coming years because of theirexpertise and network in the complex task of aggregating, sorting, grading and distributing global roughproduction. However, the European Commission and De Beers have agreed to a number of approachesdesigned to increase the rights of its customers, including an ombudsman to settle disputes. In addition, DeBeers must now give customers six months notice if it wants to cancel a contract, up from three months now.Instead of finding out the quantities of stones that they will be getting on the day they receive them, customersare now expected to be notified six months in advance. This new system is expected to introduce more flexibilityinto the market, and expected to assist India in firming down sources of rough diamonds. Apart from sales tosightholders through DTC, De Beers also sells rough diamonds to Diamdel, the group's marketing arm for small-to-medium diamond manufacturers that do not qualify for regular sight allocations.

Because of the high labour component in the total diamond manufacturing costs, the Indian trade is lessvulnerable to fluctuations in the rough diamond prices than other higher-cost cutting centres. Although De Beershas a dominant control over the world supply, the bargaining power of Indian industry is enhanced by the factthat the suppliers have very few alternative customers (cutting and polishing) for their cheaper range of roughs.India's off-take of DTC's sales has increased in recent years-from 17.6% of DTC's sales in 2000 to 28.2% in2004. Further, the multi-channel supplier of cheaper roughs (DTC, Argyle, etc) give the Indian industryconsiderable leverage over the DTC: sightholders can demand allocations of better quality goods as a`precondition' to their willingness to take cheaper roughs, or they can reject better goods when market conditionsfavour that course of action.

3 Recently, De Beers India and HDC have entered into a Memorandum of Understanding whereby HDC will subscribe for a

26% interest in De Beers India by investing US$3.75 million in De Beers India, which was incorporated primarily for the purposesof exploration and mining of diamonds in India.

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India's Purchases from DTCUS$ million

Compiled by ICRA

KEY ISSUES FACING THE PLAYERS

Large Presence of Unorganised Sector

The bulk of the GJ industry in India is concentrated in the unorganised sector and employs around 2 millionworkers serving over 0.1 million gold jewellers and over 8,000 diamond jewellers. The majority of India'sdiamond workforce is employed by small units, that process diamonds on a job-lot basis. At the low-end, family

units process diamonds/make jewellery. However, the share of the unorganised sector in the Indian GJ businessis declining. For example, according to a survey commissioned by GJEPC, the share of the organised sectorin diamond processing increased from 9% in 1995 to 45% in 1998. This was because of the shift in processingtowards higher stones, implementation of advanced cutting techniques, and preference of buyers towards fewersellers.

The centre of India's GJ industry is Mumbai. Most imports of gold and rough diamond arrives in Mumbai.However, most of the processing of diamonds takes place in the neighbouring state of Gujarat, mostly in Surat,Bhavnagar, Ahmedabad, Bhuj, and Navasari. Gujarat accounts for an estimated 80% of the diamonds processedin India. Of this, 90% are processed by around 10,000 diamond units located in and around Surat alone. Therest of the diamond units are located in Ahmedabad, Palanpur, Bhavnagar, Valsad and Navsari. Mumbai itselfhas an increasing number of modern semi-automatic factories and laser-cutting units. Indian diamond merchantshave good international reach having offices in Antwerp, New York, Los Angeles, etc. The diamond processingindustry has spread from the State of Gujarat, which accounts for almost 80% of the diamonds processed in

India, to other States. Surat, Ahmedabad and Bhavnagar are the diamond centers of Gujarat. Many diamondprocessing units have been set up in Mumbai in Maharashtra. There are also diamond processing units inTrichur in Kerala, Coimbatore in Tamil Nadu, Jaipur in Rajasthan, and Goa. Mumbai continues to be the maindiamond trading center of India accounting for the dispatch of 93% of diamond exports.

Indigenous production of CPD was earlier achieved by using semi-automatic dops. These dops turn from onefacet to another through a pawl and rachet mechanism giving a pre-determined angle of rotation and tilt.Presently, nearly 0.4 million semi automatic dops are estimated to be in use in the diamond processing industryin India. However, laser technology was introduced in the early-1990s for operations like cleaving and sawing.More than 500 such machines are estimated to be in operation in India, thereby enhancing production efficiencyand quality. In the laser technology in diamond cutting, a rough diamond is placed on a rough scanner tableor stage, between a camera and a light source. As the stone is rotated, hundreds of images are captured, anda virtual three-dimensional (3D) model is built. After building a skin model of the rough stone, the equipmentthen locates internal inclusions. The inclusion position is marked more accurately than a human can estimateits position. For instance, if a large and a small stone are being planned, most markers will err on the safe side

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to keep inclusions out of the bigger stone. Advanced algorithms then calculate the most valuable ways to cutthis gem taking weights and clarity grades into account. A laser that can be moved up and down, and focusedin and out, shines on the stone as it rotates, and a fine line is burned along the planned sawing direction. Theline is then used as a guideline for traditional sawing or high-powered laser sawing (vapourising). Other

technological improvements are introduction of diamond impregnated scaives, electronic bruters, etc. Theseimprovements along with the adoption of computerised systems for production and quality control in largefactories have enabled the ascent of the Indian diamond industry in the diamond value chain. Indian companiesare now venturing into processing of larger and expensive stones. While incredibly precise, computerisedmachinery is now used in some parts of the cutting process for some diamonds, most of the work is stillperformed by hand using exacting and meticulous techniques.

Recent Increase in Gold Jewellery Consumption

In India, gold jewellery consumption is sensitive to both income growth and price increases. In recent years,gold jewellery consumption in India is also facing increasing competition from diamond jewellery, white andbrown goods, and alternative investment vehicles. As discussed above, gold remains the predominant portionof Indian jewellery offtake.

Jewellery gold demand peaked in India peaked at 659 tonnes in 1998. The peak in 1998 came in the wakeof freeing of imports in November 1997. However, demand subsequently declined to a low of 459 tonnes in2002, because of slowdown in agricultural production and the significant increase in gold prices commencingfrom January 2002. Gold jewellery demand increased 8% during 2004 to 518 tonnes in 2004. During 2005,India's gold jewellery demand increased 13.8% to 589 tonnes or around Rs. 390 billion in value terms. Demandincreased because of a strong economy, the positive impact on rural incomes of high agricultural prices for keycrops and a good winter harvest, and an increase in the number of dealers and retail outlets. However, thecontinuing rise in prices has dampened demand during 2006, with consumption of 103 tonnes during January-March 2006, representing a decline of 38% over the corresponding previous. Domestic gold jewelleryexpenditure, in terms of the value of the gold content purchased, peaked at Rs. 302 billion (Rs. 311 per capita)in 1998, when total Indian gold demand was 775 tonnes. Since then, expenditure declined to Rs. 279 billion(Rs. 284 per capita) in 2002. However, the rise in prices since early-2003 has led to increase in gold jewelleryexpenditure to Rs. 390 billion in 2005 (Rs. 345 per capita).

The Iraqi war in the Middle East and concerns about terrorism have resulted in rising gold prices. Averageannual gold prices increased 8.6% during 2005 to 444.5/oz, as compared with increases 12.7% during 2004,and 17.2% during 2003. Prices have surged further during 2005 to an average of US$675 in May 2006.Movements in world oil prices and the associated concerns over the possible implications for inflation haveincreased investment demand for gold by 16% in 2005, and had a strong influence on world gold prices,particularly since the latter part of 2005. Other factors behind the recent increase in gold prices include ongoinggeopolitical tensions, continued subdued growth in world mine production and an increase in fabricationdemand in India, the Middle East and China.

Trends in Gold Pricesper oz.

Compiled by ICRA

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The factors supporting continued increasing demand for gold remain largely in place. These include high USdeficits, and a weak US dollar. Buoyant jewellery fabrication demand, which picked up during the period of lowerprices in mid-2004, is likely to be critical in preventing prices from declining. This is perhaps highlighted by theIndian market which is responsible for more than 20% of fabrication and bar hoarding demand, where offtake

increased at high rates in 2004 and 2005, despite a significant rise in rupee prices (and rupee prices hittingrecord levels). For 2006 as a whole, investment demand for gold is expected to continue to be supported bya number of factors, including individuals purchasing gold as a hedge against a potential increase in globalinflation (driven by high and volatile world oil prices); ongoing concerns about the large US current accountdeficit (and the potential impact on the US dollar); uncertainty over Iran's nuclear program and the potentialimplications for global oil prices; and continued speculation about potential gold purchases by central banks.Other key factors in propelling the rise in prices include the rise in producer de-hedging (resulting in reductionin mine supplies). While mine production is forecast to increase, official sector sales are expected to declineas central banks that are not signatories to the Central Bank Gold Agreement increase their holdings of gold.

Typically, India accounts for 20% of global gold offtake in any one year. India's off-take of gold jewellery percapita is low as compared with other countries, reflecting the widespread distribution of the rural population andthe social infrastructure of the country (the rural population accounts for approximately 70% of national golddemand). However, offtake in terms of GDP is high. At just over one gram of demand per US$1,000 of GDP,

India stands third in the world, behind only the UAE (just over two grams), and Bahrain.

Limited Potential for Greater Value Addition in Gold Jewellery

In India, jewellery consumption is primarily of gold. The bulk of the Indian jewellery buying is still rooted intradition, and jewellery is sold in traditional designs. Gold jewellery is fabricated mainly in 22-carat gold and,lower caratage is not favoured as the Indian mindset does not accept low purity gold jewellery.

Gold jewellery is primarily bought as an investment in gold as a store of value, and buyers do not prefer toinvest in a low purity product. Designer jewellery is generally not very popular and may not pick up significantly,because the investment is made for the gold content in the jewellery. The bargaining power of the buyer istypically limited to the fabrication charges.

Confidence has been the anchor of the gold jewellery trade in India. A jeweller or goldsmith of reasonable

standing in a local area has a fixed and loyal clientele. The buyer has implicit faith in his jeweller, and maynot negotiate too much. Standardisation of jewellery designs across the country is not feasible due to the pre-dominance of local tastes. In the present system of selling gold jewellery, the purity may or may not be asmarked, and the buyer can lose. The original labour component is also a loss when gold is sold in the market.Cheating on caratage (and purity) is widespread. Thus, in 2000, the GoI introduced voluntary hallmarking ofgold jewellery through the Bureau of Indian Standards (BIS). The system of hallmarking is expected to increasethe buyer's confidence in the jewellery's purity. However, the progress on hallmarking has been slow. Presently,the BIS grants hallmarks for jewellers from one of its 34 facilities, but only as demanded as this is voluntary.BIS also expects to expand its facilities to cater more for gold jewellers in rural areas and small towns aspopulations from these make up 70% of the gold demand in the whole country. It is estimated that just one suchassaying centre could cost US$12 million. Recently, the GoI has announced that hallmarking of gold will bemandatory from January 1, 2008. This is expected to eliminate cheating on caratage (and purity), which iswidespread in India. To ensure that all jewellers comply, the BIS will charge Rs. 10,000 for a three-year licence

if the jeweller is from outside a metro or district headquarters. Jewellers within district regions will be chargedRs. 20,000 for a three-year period, while those in metros will be charged Rs. 25,000.

Possible Long-term threat from China

Although India currently enjoys dominance in the world's cut and polished diamonds market, China may emergeas a viable rival, if not in the near term, certainly in the longer term. An increasing number of diamond processorsfrom Israel and Belgium, and even India, are setting up facilities in China, for a variety of reasons: (a) the labourforce, like in India, is cheap and disciplined; (b) high economic growth over the past decade has resulted ina significant increase in potential consumers in the high-income segment within the country; by comparison,India has to rely almost solely on exports; (c) quality of Chinese workmanship is steadily improving. However,India still has an overwhelming advantage over China. China processes an estimated 3 million carats ofdiamonds annually, as compared with 180-200 million carats in India. China has about 0.03 million peopleworking in the industry, compared to India's well over a million. India exported CPD aggregating US$11.2 billion

in FY2005, as compared with around US$1 billion by China. However, China has rapidly become the world'ssecond largest diamond manufacturing centre, when measured in manpower terms.

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Technology is another area where the Indian industry faces a long-term threat from China. Until now, acombination of manual skill and semi-automatic machines have helped the Indian industry to maintain aleadership position. However, China with its modern and automatic factories is today in a similar position tomanufacture jewellery at competitive prices. Increased competition will force the Indian industry to focus on

higher-end products, with the concommitant requirement of increased investment in modern technology.

Threat from Polishing in Producing Nations

Over the last few years, there has been increased political pressure by major diamond producing countries inAfrica-Botswana, Angola, Namibia and South Africa-to gain further economic benefits from diamond productionthrough jobs creation in a domestic cutting and polishing industry. Most of these countries have no history ofdiamond polishing but the skills can be taught as has been seen by the recent rapid growth of jobs in othernon-traditional centres such as the Far East and Armenia. The pressure towards polishing in the producingcountries is growing and increasingly it is a part of the overall agreement permitting mining, or of not imposinghigh taxes. As a result, De Beers has recently announced restructuring of their sorting and sales operationsto support the CPD industry in South Africa, Botswana and Namibia.

The Indian diamond industry has thrived because for economic reasons, most smaller stones cannot be

profitably cut in higher cost locations. However, with larger (and higher-value) stones, the cost disadvantageis not a significantly material component of the finished value of the stone, and higher cost polishing can beeconomically feasible.

In Russia, an increasing proportion of Alrosa's Russian output has been sold to local polishing factorie

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