It is well recognised that gold and silver have tremendous historical, religious, cultural, social and economic significance in our country. Copious references about bullion can be found in our mythologies, epics and other literature over centuries or even millennia.

Along with China, India is by far the world’s largest importer and consumer of gold. Approximately, 20-25 per cent of global production is consumed in India. By volume, the country imports about 700 tonnes a year, accounting for over a fifth of world jewellery fabrication. The value of import is approximately $40 billion (about ₹2.6 lakh crore).

Despite being a large importer, India’s per-capita demand for gold is relatively low. Demand for the yellow metal is highly income-elastic and price-elastic in a developing economy such as India. Higher incomes drive demand up, as do lower prices. On the other hand, high prices without corresponding rise in incomes will lead to demand compression.

What drives demand

Farm incomes, marriages and festivals are the main demand drivers. A good monsoon results in a rise in rural incomes, which in turn drives up demand for bullion. As incomes rise, consumers at the lower end tend to graduate from silver to gold to an extent.

Be that as it may, in 2017, geopolitical uncertainties, accommodative monetary policy and currency gyrations (especially the US dollar) generally proved to be supportive of gold, as a result of which prices recovered from their 2015 lows. Yet, the metal established a series of higher lows this year on the back of near-record mine output, while jewellery fabrication has languished at multi-year lows.

The value of global investment in gold is currently estimated at about $44 billion, and the good news is that retail investment is seen picking up.

Current prices (below $1,300 an ounce) mean that gold mining is not profitable for many producers who are now obsessed with cutting costs in order to stay afloat. This means that the gold industry is not investing enough in exploration, which can potentially tighten supplies in the years ahead.

Despite India being one of the largest gold consumers, the price of the yellow metal is determined in the London and New York markets. In other words, India is a price-taker and not a price-setter.

Impact of policies

Meanwhile, several policy and regulatory issues have in recent times stymied orderly growth of the gold market. This humungous consuming market faces challenges that include a lack of standardisation (for bullion), complex and changing government policies, non-uniform pricing, poor transparency and a high incidence of cash transactions.

Steady increases in Customs duty (to 10 per cent ad valorem at present), launch of the 80:20 rule (which was subsequently withdrawn), compulsory identification of purchasers above a specified value threshold through Permanent Account Number (PAN) cards and the introduction of the Goods and Services Tax have from time to time impacted the market. Also, for a brief while, the gem and jewellery sector was brought under the draconian Prevention of Money Laundering Act.

As a result of these developments, the decline in investment demand is palpable. The clampdown on unaccounted cash, which usually tends to flow into safe-haven assets such as gold, and the demonetisation of high-value currency notes in November 2016 discouraged potential consumers. Additionally, robust stock market performance may have contributed to muted market conditions for the yellow metal. The Gold Bond Scheme has also evoked tepid response.

What the future holds

Where do we go from here? Primarily, the physical gold market needs strict regulatory oversight across the value chain—right from import, pricing, disposal of imported material, conversion to jewellery and eventual sale to customers. Admittedly, creating an audit trail is a daunting challenge; yet, it needs to be enforced in the interest of sound economics, transparency and consumer protection.

India’s gold refining industry needs to match up to global standards to ensure purity and quality assurance. Currently, there is a distinct lack of trust in the purity of the metal. Hallmarking should be popularised, and the associated costs slashed.

The demand for reduction of Customs duty on the yellow metal from the current 10 per cent should be weighed against revenue implication and the fact that gold is a demerit and non-essential commodity.

Deepening the gold derivatives market through institutional participation, including banks and mutual funds, as well as a well-regulated spot exchange for gold as an adjunct to the derivatives exchange may be considered.

The author is a commodities market specialist. Views are personal