Opinion

Are spot gold exchanges the answer?

Sarat Mulukutla | Updated on June 07, 2018

There is an urgent need to promote Made-in-India gold to unlock reserves, curb imports and create a vibrant domestic market

In possibly another attempt to unlock the vast gold reserves held by households in the country, the Finance Minister, in his Budget speech on February 1, 2018, announced the setting up of ‘regulated gold exchanges’.

Gold exchanges have been mooted in the past to address the peculiar problem of this ‘dead asset’. India has savings held in the form of gold to the tune of 20,000-25,000 tonnes ($800 billion to $1 trillion). These gold holdings lie with various institutions, trusts, temples and households. Money locked up in the form of gold is unavailable to the Indian economy and is therefore a ‘dead asset’.

The problem worsens each year as India continues to import approximately 700-900 tonnes of gold annually (only a small portion of imports get re-exported in the form of jewellery).

The import of gold not only worsens the trade deficit but continues to add to the unproductive gold holdings in the country. In the light of India’s high dependence on foreign capital for growing its economy, there is no doubt that it must monetise this ‘goldmine’.

On the face of it, creating just another avenue to trade gold in India will add no economic value. Two commodity exchanges — NCDEX and MCX — in the country already trade in gold derivatives.

What the country needs is a spot exchange that curbs the appetite for gold imports and simultaneously encourages Indians to release their savings locked in the form of gold.

To develop such a spot exchange, certain critical factors must be considered:

(1) Keenness of Indian households to sell gold, which will be heavily influenced by the questions that may be posed by Income-Tax authorities.

(2) The price that sellers receive for their gold holdings (which in all probability will not be of 22/24 K purity).

(3) The common man’s confidence in the assayer and the process of assaying.

(4) A liquid and deep market for Made-in-India gold.

Major hurdles

For various reasons, gold lying with many households will not have supporting documents such as receipts showing when they were bought or proof of inheritance/gift/streedhan, etc. This will make it difficult for households to convert their gold holdings unless an amnesty of some form is offered. However, the government will be wary of such an amnesty scheme because of concerns that it would be misused for converting ill-gotten money to white. This is a difficult problem to solve and is arguably the biggest hurdle to unlocking households’ reserves of gold.

The purity of gold refined in India has always been a matter of concern. Even now, while MMTC-PAMP and some others have started providing gold bars and coins of high purity and impeccable quality, most buyers still prefer Swiss and other imported gold bars.

Interestingly, China and India, despite being the largest consumers of the yellow metal, hardly play a role in the price discovery for gold. The price discovery takes place in international markets: OTC markets in London and COMEX in the US.

We are price-takers. We adjust the international price of gold by the cost of transportation and the premium/discount prevailing in the local markets. This methodology has been working too well in the Indian markets for the proposed spot exchanges to bring about any change, at least for the first few years.

Another problem that ails the gold and gold jewellery sector in India is the quality of gold available with various jewellers. Scrap gold, which is of varying purity, gets the best price at the jeweller from whom one bought the original piece of jewellery — simply because the jeweller stands guarantee for the quality of the gold he has sold. Any other jeweller will insist on assaying and offer a much lower price as most ornaments, though sold as 22K, have a much lower gold content.

The solutions

There is enough and more gold already in India that can satisfy the demand for new gold thereby obviating the need for imports. The problem so far has been the absence of quality standards for gold refined in India, a gap that NCDEX’s good delivery standards can bridge.

The perception about gold refined in India has to change and efforts have to be made to create policies and standards for Made-in-India gold.

There is no doubt that gold refined in India can match LBMA standards. In a study by NCDEX, four refiners out of 17 in India passed the due diligence conducted by Alex Stewart (one of the leading independent inspection and metal assayers in the world, acknowledged and accredited by reputable institutions such as LBMA), along with SC Saha, and MP Chitale & Co.

Made-in-India gold will not only help reduce our import bill but also lay the foundation for a vibrant domestic market for gold.

Made-in-India gold has to be promoted heavily within the country at all levels so that the appetite for imported gold reduces.

Investors should have the confidence that the gold bars refined in India are as good as bars available globally.

Unethical trade practices at the retail level have to be curbed. Retail investors must be able to resell gold without having to take a cut.

Some efforts in this direction have already been initiated but they are not enough. Retail participants will be truly happy only if they are able to enter and exit gold investments very easily. This can be done by dematerialisation of gold holdings. Similar to demat shares, demat gold investments will pave the way for many citizens to invest in gold without the hassle of storing their gold holdings.

Gold ETFs were supposed to provide an avenue for hassle-free investments in gold but they have not been successful for various reasons.

Dematerialisation of gold holdings will make gold truly a financial asset in the country. As a result, the government will not have to design complicated gold deposit/monetisation schemes to unlock the savings tied up in gold.

These measures will help create a multi-tier gold market in India with institutional participation (banks, mutual funds, PMS, hedge funds) in both the spot and derivatives segments.

Over time, the Indian market could well start dictating the price of gold and cease to be a price-taker.

Establishing gold exchanges is a good move — but it is critically important to get the objective right.

The correct objective would be to facilitate trading in Made-in-India gold or gold refined in India. This will automatically pave the way for many golden dividends!

The writer works for the National Commodity and Derivatives Exchange.

Published on June 07, 2018

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