By Sanjiv Arole
The first two decades of this century saw a debate raging among the Indian freedom fighters. The point of contention between the two protagonists -- Tilak and Agarkar -- was whether India should have political freedom first and initiate social reforms thereafter, or reform the social fabric first and only then push for political independence.As the world heads for the end of this millennium, a similar debate is on in the country’s bullion markets. Should India fully open its bullion markets by setting up a bullion exchange, a la Turkey (see Turkey: A role model)? Or, should it continue at a slow pace and set its house in order, before opening up totally?
Why gold reforms?
The global studded and plain gold jewellery market is in the region of $70 billion. Of this, India’s share is a mere $850 million plus, hardly 1.5 per cent. A workshop organised on India’s jewellery exports by the World Gold Council (WGC) last December targeted a 10 per cent market share by 2005. But this cannot be achieved if India does not have a developed bullion market.
A bullion exchange is more urgently required now considering the fact that during the period between 1962-1990 the Indian bullion market was in a state of hibernation, thanks to the obnoxious Gold Control Act.
The bullion trade is quick to point out that the Gold Control Act was introduced ostensibly to save precious foreign exchange, a plan that went hopelessly awry. Moreover, it was erroneously believed then that futures trading would lead to speculation and thus harm the trade as it would keep gold prices at high levels. It took successive governments almost 30 years to realise that India’s warped policy on gold has only caused centres like Dubai and even Singapore to prosper. So much so that after gold imports were permitted under OGL, Dubai’s role as an entryport of gold into India dwindled dramatically. Similar was the case with Singapore.
Further, the Gold Control Act meant that the supply of gold went into the hands of the unscrupulous trader. The parallel or black economy received a big boost. The trade virtually went underground and quality went downhill. Cheating became rampant and consumers had no recourse because whatever they bought was often not backed up by even a receipt. It was all cash and the biggest loser was the consumer.
Additionally, if one looks beyond home, at the rapid strides that neighbouring countries have taken in capturing the export jewellery market, it will become apparent that India has indeed paid a heavy price for closing its bullion market for so long. Thailand, a case in point, has captured a substantial share of the jewellery export market over a period of time and Malaysia consumed just about 9-10 tonnes of gold while exporting more than 75 tonnes annually in the mid-1990s.
In the last decade or so, along with the diamond industry, jewellery exporters have been able to import gold under the replenishment scheme. But, while India has captured more than 50 per cent of the cut and polished diamond trade at more than $5 billion, it has made no significant headway in the export of plain gold jewellery as against a healthy growth in the studded jewellery segment.
The facts that the domestic market for studded jewellery is not big enough, and that the diamond industry has been regulated by De Beers, which promoted India as a major cutting and polishing centre in the 1980s, worked in favour of the diamond industry. The factors that probably worked against the gold jewellery sector were the tags of poor quality and outdated designs.
The bullion trade has thus been canvassing for reforms for a long time now. The current generation in the trade is an impatient lot and wants the bullion trade to open up totally. They want derivatives trading for all in the trade. More so, after the recent volatility witnessed in gold markets. Forward and options trading can, if prudently used, minimise the losses accruing on account of wild fluctuations in prices, they feel. This new breed of professionals understands that the reform process is moving at a healthy pace. But it wants the pace to quicken further.
Most of them would have preferred India to follow the Turkish example (see page VII) and open up its bullion trade even before its economy had been opened. They reckon that the $70 billion plus market is difficult to crack and, therefore, the sooner India gets a developed bullion market the better. The sector requires huge investments for it to be competitive in world markets. Professionalism and corporatisation of this unorganised sector is a prerequisite to tap the export market.
It hurts that, though India consumes about a third of the total supply of gold mined in the world annually and has private hoards worth 10,000 tonnes plus of the yellow metal, it has no say in the international bullion trade. The only role India plays in the international gold markets is that of propping up the price-line through its voracious appetite for gold. As in world diamond business, India now wants to play a more central role in world gold trade. And it wants to be the focal point for both the trades now and not a couple of years hence.
The immediate recipe
The new brigade in the trade wants immediate action. The feeling is that a meticulously planned pace of reforms would work fine. But what worries them are wrong signals like the sudden hike in import duty on gold at the beginning of the year and the continued effort by a strong lobby to put gold off the OGL list. Some suggestions coming from within the trade and outside that surely warrant a look are:
The market for domestic gold loan is small and it is not desirable to have gold loans to fund other long-term projects (no diversion of funds). Banks will have to sell some amount of gold and hedge it forward in international markets.A bullion exchange will help the local industry to hedge their risks and jewellers would then be able to concentrate on making money from designs and labour (free from gold price risk and, therefore, free from malpractices regarding purity). It is imperative that the bullion exchange includes silver as well.India can have a separate depot for international banks/bullion houses to trade their (consignment) stock lying in the country. India can be a distribution hub for bullion for the whole of Asia or at least for SAARC and the Middle East.Something in the line of London Metal Exchange’s (LME) offshore vaults in Singapore for base metals. Material from Australia, etc. should come directly to India and not via London or Zurich. Savings on silver freight alone could be significant!Other products like gold certificates, GAP, gold gift vouchers, etc.At present, gold loans in international markets are available below 2 per cent; such gold loans can be availed of in India through institutions like PEC, MMTC & HHEC. Cost of such a loan against a bank guarantee or otherwise would work out to between 2 per cent and 6 per cent for the borrower. Jewellers should be encouraged to offer 100 per cent cash/government securities for drawing gold loans.Gold loans for the export sector in small quantities of 3-5 kgs and above. Reserve Bank of India (RBI) could be asked to deposit some gold from its reserves with the State Bank of India (SBI) and the latter could lend the same at around 1.5 per cent to exporters for them to be competitive in international markets. RBI could deposit 10 tonnes of gold lying idle in its vaults, more than enough to meet the annual demand of exporters.SBI could tie with one of the major bourses to list gold bonds as a substitute for physical gold.The old bullion exchange in Mumbai could be revived either as an independent exchange or as a segment of the existing stock exchanges like the Bombay Stock Exchange (BSE) or the National Stock Exchange (NSE).Development of such markets would drive speculators away from the physical bullion, thereby benefiting the trade. This could also reduce the pressure on forex resources. It will serve the entire trade by allowing easy liquidity for paper or physical gold. It could also provide the ideal platform for hedging any gold price risk.A gold accumulation plan (GAP) as a corollary to the gold deposit scheme.Slow and steady
Arguing against rushing headlong into reforms and forcing their pace are the conservative lot. They believe that after being on the right track for the last nine years, all should not be lost on the home stretch by being hasty.
They also feel that much more needs to be done before a bullion exchange can be set up in the country. Only then could one look at India becoming a focal point of world bullion trade. The factors that need to be considered first are:
An efficient spot and forwards market, sufficient liquidity, regular, safe and cheap supply system with good delivery standards are some of the prerequisites for smooth functioning of a bullion exchange. While the GDS, hedging facility for banks and a number of other gold related initiatives being planned by the government and the RBI are steps in the right direction, it is necessary to resolve issues on uniform sales tax rates, other local state levies, Forward Securities Contract Act, acceptable uniform pricing mechanism, etc. before reviving the bullion exchange. The above issues need to be addressed before a bullion exchange is set up.Since liberalisation was set in motion, efforts have been made on part of the regulators to slowly revive the gold market, in sync with the other sectors of economy.While a country like Turkey has completely opened its gold market before opening its economy, India has followed the policy of simultaneous and consistent liberalisation of all sectors of its economy. The policy of slowly but steadily liberalising the Indian economy will prove extremely beneficial in the near future. For, the danger in hastening the pace of reforms is that without any proper regulation things could go awfully wrong.Faster, faster
The counter argument is that just because there are Nick Leesons, Hamanakas and Harshad Mehtas in the world, one does not stop trading in equities or commodities. What needs to be done is improve the checks-and-balance system. Just as one cannot earn less to pay less tax, the pace should not be so slow that you may miss the boat. The world is already moving into e-business. If India decides to move slowly on reforms by following the traditional route, it could find itself overtaken by the rest of the world. It is not just about setting up a bullion exchange but also about catching up with the latest trends in the world of net trading. The world is on the threshold of a new business millennium. Unless India moves fast, it will always find itself lagging far behind the others.
Conclusion
But disputes between the two schools of thoughts are only on the pace and the strategy of the reform process. Both sets agree that:
For India to become the focal point of world bullion trade a bullion exchange is a logical progression;There is a vast potential on the gold jewellery export front;There is a need to use India’s huge gold reserves and consumption habit to good effect.The bullion exchange could become a reality in two years’ time on a conservative basis. And it will not be beneficial to India alone. Gold has been going through a lean period for a long time now. Who knows, India with its phenomenal consumption and vast reserves could just be the market that is waiting to explode. If the bourses in India can rank among the top five in the world (in terms of size), then an Indian bullion market could be only bigger.
Perhaps, just what the doctor ordered for gold!