Indian regulations also need to allow (and even encourage) participation of financial firms—banks, mutual funds, alternative investments funds—apart from physical value chain participants in the gold spot exchange.
By V Shunmugam & Niteen Jain
“When we have gold, we are in fear; when we have none, we are in danger”
As it is with individuals, so with sovereigns. An early response to the economic crisis in Venezuela was its central bank’s (BCV) liquidation of its gold reserves (in 2015) to pare its debt. The bolivar, its currency, had become so useless that it was cheaper to use the currency notes as napkins. Likewise, the East Asia financial crisis two decades ago saw ordinary South Koreans join the national campaign to mobilise gold and pay-off IMF bailout loan. The 226 tonnes of gold mobilised from nearly a quarter of the population may have been a pittance, but it clearly demonstrated the spirit of the people and the economic significance of the yellow metal in times of crisis.
Intuitively, the 25,000 tonnes of gold Indians hold clearly has a greater potential for the country, not only as a safe haven in times of economic upheavals, but also as a source of finance that can support real economic growth if this stock can be connected to the organised financial sector. Gold, any way, has a significant beneficial impact in India, with the gems and jewellery sector contributing 7% to the country’s GDP and 15% to total merchandise exports, besides employing over 40 lakh workforce.
However, for the yellow metal to play out its real economic strength in the country with a millennia-long and strong cultural affinity towards gold, there is a dire need for institutional mechanisms that help unlock its value and channelise the benefits of this into the real sectors.
Over the years, the policy has largely been juxtaposed between tightening gold imports—as gold is seen as a large but unproductive import item, and developing the indigenous gold economy. The pursuit of the latter is now expected to get a major fillip following return of the NDA at the Centre, which had, in 2018, announced its intention of developing ‘gold as an asset class’.
Of the various measures expected towards this end, the proposed establishment of gold spot exchanges is arguably the most significant game changer amongst all. Gold spot exchanges are expected to fundamentally alter the way transactions in gold are currently done, mobilise household gold into mainstream economy, and spawn efficient financial instruments with gold as the underlying.
So, what are the prerequisites for a successful gold spot platform? Apart from the existence of a strong and autonomous regulatory body, clear regulatory architecture, well-established quality standards and good delivery norms, a new institution like a gold spot exchange needs to be supported by necessary and nifty policy enablers, some of which include:
Well-distributed vault network: India’s gold economy is made up of diverse participants—retail consumers, banks, large trading houses and AMCs, to lakhs of jewellers and goldsmiths. A vaulting network, under appropriate regulations, associated with gold spot exchange is essential to induce necessary interest and trust amongst such a diverse set of participants spread across the Indian geography.
A wide geographical spread of vaults would not only facilitate easy delivery of the metal, but also aid in efficient price discovery in far-fetched physical markets. Besides, electronic record keeping of the vaulted gold stocks under regulations will a long way to connect the stakeholders with the formal markets for finance.
Backed by ambitious policy reforms, the Shanghai Gold Exchange (SGE), one of the world’s most successful gold spot exchanges, had, by 2016, a network of 61 gold vaults spread across 35 cities, facilitating vaulting, title transfer and delivery of gold in line with trading needs of the stakeholders of the SGE platform. As much as 67,500 tonnes of gold was traded and 11,600 tonnes delivered on the SGE platform in 2018.
Instituting a benchmark price: A sore point in India’s otherwise glittering gold economy is her absence of pricing power, despite the country being one of the world’s largest gold consumers. With a supportive policy regime that promotes mainstreaming of gold investment, a widely-acceptable and referenceable India Gold Price can emerge.
A gold spot exchange can surely catalyse such an emergence, just as the SGE that had launched and popularised the Shanghai Gold Fix. Despite its short history of the past three years or so, the Shanghai Gold Fix commands a healthy correlation of 99.6% with the LBMA (London Bullion Market Association) fixings. Such an Indian benchmark can be used to price Indian gold ETFs, which are today pegged to LBMA fixings.
While an Indian benchmark will add to the transparency in physical market transactions, it can also be used for transparently pricing gold for public schemes such as the Gold Monetisation Scheme and Sovereign Gold Bonds, apart from breeding innovative gold-based finance schemes. This will eventually strengthen the foundation, and help internationalisation of the India Gold Price.
Diversity in trade participation: The vibrancy of a marketplace has a direct and strong relation with the diversity of its participants’ profile. London is a centre of global gold trade, despite the UK being neither a large consumer nor a producer of the metal. The holy grail of this gold trading hub is the unfettered participation it allows in its markets.
To emulate this example, Indian regulations also need to allow (and even encourage) participation of financial firms—banks, mutual funds, alternative investments funds—apart from physical value chain participants in the gold spot exchange. The exchange would also need participation of foreign entities—miners, refiners and foreign financial firms—to fully reflect the global fundamentals of gold in the Indian price, as well as create products, processes and infrastructure for lending vibrancy to the Indian gold market.
It is little surprise that the Shanghai Gold Fix, which is emerging as a reference price in East Asia, is arrived at from the prices quoted by its hugely diverse participants: domestic and international banks, large retailers, miners, etc.
Broadening the scope of exchange: The gold spot exchange platform can and should be leveraged for introducing other products and services such as deferred trading, swaps, gold leasing, etc, which can help unlock the real value of gold beyond being a form of wealth.
Building on existing trade processes and infrastructure created by the gold derivatives market and enabling fungibility between spot and derivatives platforms can offer a host of benefits for the common users of these platforms. The economic benefits to the stakeholders in the market can be enhanced by way of fiscal incentives, which will go a long way in promoting transactions in a formal and transparent marketplace; for example, trading of standard gold on the SGE is exempt from VAT.
In a country like India where gold has deep sociocultural roots, any effort to develop the gold economy holds huge significance from India’s domestic economic needs and wielding its economic power in an appropriate manner. The anticipated flow of benefits from gold spot exchanges are, expectedly, large—whether in making Indian prices more transparent and providing a benchmark for intra- and international transactions, popularising quality standards that propel gold jewellery exports and the country’s nascent refining industry, creating and driving recycling standards and norms, or giving a fillip to policy efforts for monetisation of physical gold. Yet the expectations are not unfounded.
Apart from the SGE and the rise of Shanghai as a counter to London, as noted above, the vibrancy of Istanbul’s financial market is a direct offshoot of Turkey’s main exchange, Borsa Istanbul, being the gateway for gold imports, in turn creating an efficient and formal gold market structure in Turkey.
To reap the economic benefits of the largest gold deposits above the earth’s surface available with India’s economic stakeholders, to use it to appropriately to connect with the global and domestic markets, and to finance the wheels of its economic growth needs, it is essential that the policymakers move ahead with the right institutional support and an enabling regulatory and policy environment, to set up national electronic spot markets for the yellow metal.
(Authors are head and senior analyst, respectively, Research at MCX. Views are personal)