India is the world’s second largest gold consumer with an annual demand of nearly 1,000 tonnes. In spite of this, the country lacks many key elements of an efficient gold ecosystem.
Problems with the Indian gold market:
- The gold market here is plagued by fragmentation.
- Prices vary significantly across channels and locations.
- The quality of gold also varies widely.
- Jewellery rather than gold bars, gold coins, or gold-linked financial products, still dominates retail demand.
- Large jewellers and traders mostly import refined gold from international markets, such as Dubai, causing loss of economic value and jobs in India.
What can we learn from other countries?
With the global gold market shifting from the West to the East, many Asian countries, such as Turkey, China, Singapore, and the UAE, have set up global-scale physical infrastructure for refining, storage, transport, trading and financing of gold to cater to the spurt in demand in the region.
Gold exchanges and related infrastructure set up by these countries have greatly enhanced the efficiency of their gold markets by way of:
- Efficient price discovery.
- Quality assurance.
- Active retail participation.
- Use of gold bars and gold coins.
- Use of gold-linked financial products instead of jewellery for investment purposes.
- Greater integration with financial markets through gold leasing and lending.
Key facts on Indian gold market:
- Large players in the country procure gold directly from miners and traders in overseas gold hubs, often at a discount to the benchmark London Bullion Market prices.
- Medium and small jewellers mostly depend on large players for supply of gold and face significant cost disadvantage.
- Resellers are a significant source of gold for jewellers and refiners. However, there is no transparency in the activities associated with reselling of gold into the market.
How can we improve India’s situation?
According to a survey conducted by the India Gold Policy Center at IIM Ahmedabad, a national-level spot exchange would address the above mentioned problems and benefit stakeholders through transparency in pricing and standardization.
- The survey also found that most of the small jewellers are keen to source gold through a gold exchange and, surprisingly, some large players too.
How can we improve the situation?
- Establish a domestic and an international exchange which would allow two-way trading in physical gold and also provide derivative products for hedging.
- The Exchange could also include gold vaulting facilities set up by experienced promoters, logistic arrangements to achieve next day delivery across the 21 major locations in India, and mechanisms for quality assurance and standardization of gold.
- The Exchange should also offer domestic spot gold contracts and global spot gold contracts denominated in US dollars based on delivery outside the domestic tariff area.
- Within the constraints of capital control regulations, both the domestic and global contracts on the Exchange must be open to the widest range of participants.
- All domestic entities and foreign portfolio investors should be allowed to trade in domestic contracts.
- Gold lending and borrowing mechanism (GLBM) should also be put in place.
What should the government do?
As in other Asian nations such as China, investment grade gold traded on the exchange should be exempt from indirect taxes such as VAT and GST, but should be subject to a Commodity Transaction Tax (CTT).
High standard of governance is the key if the Exchange is to aspire for leadership in Asian gold markets. These governance measures would include:
- An India-responsible gold policy.
- World class gold quality assurance.
- Risk management.
- High quality clearing and settlement.
- Regulation and supervision by a credible regulator such as Securities and Exchange Board of India.
Things to be considered while setting up these exchanges:
- Ideally, the Exchange must be promoted by neutral players (e.g. existing commodity, stock and derivative exchanges; banks; and other financial entities) instead of participants in the gold industry (e.g. jewellers, refiners and traders) because of conflict of interest.
- Partnership with gold markets in Singapore, London and Shanghai can also be considered.
- Minority equity participation by multilateral financial institutions such as the Asian Development Bank and the BRICS bank, and technical collaboration with professional bodies such as the London Bullion Market Association would be also valuable.
The Exchange would be economically feasible if it drew a minimum trade quantity of about 100 tonnes a year, which appears quite feasible, given the annual demand of about 1,000 tonnes in India and that there are many segments of the gold market that are underserved by the existing market structure. Once the Exchange is set up, the participation balloons and vibrant contracts in the Exchange become the dominant forum for price discovery and investment in physical gold.
An Exchange in India would help much to create a vibrant gold ecosystem matching India’s large share of global gold consumption, leading to efficient price discovery, assurance in the quality of gold, active retail participation, greater integration with financial markets, and greater gold recycling. It would also boost the gold monetization efforts of the centre through transparency and standardization of the gold market.