Russia's cutting-edge diamond deal

Under the deal, Russia's diamond monopoly plans to boost production and sell half of it in the domestic market

By CNN Moscow Bureau Chief Jill Dougherty

MOSCOW, Russia (CNN) -- Diamonds may be a girl's best friend, but the diamond industry has lost some of its brilliance in the past year.

The United States, which buys half the world's diamonds, is in recession. And the September 11 terror attacks weakened the market for luxury goods.

But Russia, the world's second largest producer of diamonds, is bullish on the future.

This week, Russia's diamond monopoly, Alrosa, signed a new five-year, $4 billion trade agreement with the giant diamond wholesaler De Beers.

Alrosa's vice president, Alexander Matveev, says it's a good deal for Russia.

"If we, along with De Beers, control 62 to 65 percent of (world) production, then we can dictate, along with them, general price parameters. And that's why this is good for us," says Matveev.

De Beers used to control some 85 percent of the world's diamond market. That's slipped to approximately 65 percent.

Russia itself accounts for 22 percent of the world's rough diamonds -- worth about $1.6 billion each year -- and has vast untapped reserves.

Alrosa digs for diamonds in one of the most remote parts of Russia -- Yakutia, in eastern Siberia.

Rough diamonds are extracted from the frozen earth, along with tons of dirt. The diamonds are laboriously sifted out and shipped back to Moscow, where they are cleaned and sorted.

The new deal with De Beers is also richer for Russia.

Alrosa plans to boost production -- and cut, polish and sell half of it, worth about $800 million annually, in the domestic market.

Previously, 97 percent was exported raw at a much lower price, through the London-based Central Selling Organisation controlled by De Beers.

The deal marks the first time the Russian government is not a party to the agreement.

"This is the first step of liberalization of the diamond industry in Russia," says Kaha Kiknavelidze, equity analyst with Troika Dialogue.

The new diamond agreement is a victory for Alrosa President Vyacheslav Shtirov, who, by the way, is getting plenty of help from the Kremlin in his bid to become governor of the Yakutia region. He is almost guaranteed to win this Sunday's election.

Shtirov says the deal provides new opportunities for developing not only the domestic diamond market but Russian industries such as diamond cutting.

The deal is also important to the Russian budget. Russian Finance Minister Alexei Kudrin said Alrosa contributed 6.5 billion rubles ($216 million) in taxes to the federal budget last year.

Diamond sales are critical to the economy of Yakutia, a vast region which relies on diamonds for 70 percent of its budget.

With its gleaming new store in Moscow, Alrosa is setting out to market diamonds to rich Russians. In spite of the weakness in the world economy, it says, diamonds are forever.