MUMBAI: Diamond lovers can loosen their purse strings this festive season.

Rising cost of funds and a consequent fall in raw material demand among processors have cut polished diamond prices by 10% at least over the past three-four weeks, six months after they rose by a whopping 40%.

The industry attributed the relentless price rise partly to heightened speculation in roughs, the raw material, and a widening demand-supply gap, itself a consequence of an investor shift from stocks and currencies to diamonds, being increasingly perceived as an alternative asset class.

"Polished prices have come down by an average 10% across the board, and may be more in smaller products like star melees," said Pooja Kotwani, India MD of Rapaport, a leading source of diamond price information.

"Tight liquidity in the local market and a drop in interdealer (from cutter to cutter) rough transactions with people not willing to pay the premiums they had done earlier have contributed to the correction, which is a healthy sign as the price run up was perceived to be unsustainable.

I think products in oversupply and where there is a lack of demand will correct further, though it's hard to put a figure on the extent of a likely fall from here."

India's central bank has raised its so-called repo rate, at which it lends to banks, eleven times over the past year to temper rising inflation levels. Currently at 8%, this increases the borrowing cost and reins in speculative activity in commodities and other assets.

Apart from investors who bought roughs to gain from price appreciation, some stockists also hoarded them in anticipation of higher prices. This also created an artificial scarcity in the market.

But the bad news is be that even though diamond prices have come off a bit, a greater correction may not materialise since Diamond Trading Company (DTC), mining giant De Beers' roughs distribution arm that supplies nearly half of the world's rough diamonds, marginally raised prices at last week's sight or sales meet.

A sight is where DTC allots raw material to its sightholders or polished diamond manufacturers.

So, smaller producer BHP Billiton's reduction in rough prices by 15% at its recently-concluded auction may not help much, say some in the trade.

"While BHB Billiton and Petra Diamonds have reduced rough prices by 15% at recent auctions, both De Beers and Russia's Alrosa have not cut prices, which indicates rough demand remains buoyant across the world," said Vasant Mehta, a Mumbai-based diamond cutter.

"Polished prices are currently down by 5-7%, which is good for demand that typically rises in the second half of the year."

Varda Shine, MD, DTC, which holds sights 10 times a year, told ET, "Although we don't comment in detail about our monthly sales figures, it would certainly be true to say that we recorded very strong sales at both sights, both of which are among the largest sights we've ever sold, and both of which responded to exceptionally strong customer demand."

Despite economic worries in the US and Europe, De Beers expects consumers there to turn to diamonds. "In dollar terms, we are expecting the US to continue to grow this year, following on from the 7% market growth we observed there in 2010. We anticipate a steady performance from other mature markets of Europe and Japan, and strong growth in the emerging markets. Increasingly, we are seeing consumers turning to diamonds as one of the ultimate 'hard assets' in troubled times," said Shine.

Eleven out of 12 diamonds sold internationally are cut and polished in India, which registered a rise of 10% in cut and polished diamond exports to $6.5 billion during the April-June period from a year earlier.