Backwardation: Is India's gold policy efficacious?
Wed July 03 2024
Backwardation in global financial markets denotes a condition when the current price of an underlying asset surpasses its price in the futures market. Despite India's significant strides in the gold industry over the past decades, questions arise regarding the efficacy of its gold policy. Delving into the intricacies reveals a fragmented approach that impedes the industry's potential for growth and innovation.
A Brief History
In 1997, India embarked on a journey to liberalize its gold policy, granting select banks and institutions the authority to import and distribute gold domestically. This marked a pivotal moment, catalyzing India's emergence as a powerhouse in gold consumption and jewellery manufacturing. Today, India stands as the world's second-largest gold importer and one of the largest jewelry exporters in the world, a testament to its robust market and economic vitality.
As the gold market moved towards maturity over this 27 year period and India’s economic stability enhanced, we have seen encouraging efforts such as:
The beauty of India’s gold market is that while on the one hand, it consumes a lot of precious foreign exchange, on the other hand, it generates significant employment as well as huge revenue to the exchequer via customs duty, sales tax, corporate tax, personal income tax, and other cesses, fees and so on. Not to mention the opportunity of this gold to be mobilized for nation’s needs when the situation arises (remember 1991?).
However, amidst these triumphs lies a fragmented policy framework that impedes the industry's growth and innovation potential.
Challenges Unveiled
Despite the achievements, cracks in India's gold policy framework have become apparent, hindering its progress:
a) Lack of Gold Policy Objective:
India does not have a gold policy objective as to what it wants to realistically achieve in the industry, for the industry, and from the industry, leaving stakeholders without clear direction or purpose.
b) Fragmented Gold Policy Landscape:
India does not have a single, unified gold policy – it is a mix of various circulars and notifications issued by RBI, Ministry of Finance, Ministry of Commerce, DGFT, Customs, and other relevant authorities from time to time. In order to understand what one can do and what one cannot, a number of documents have to be referenced and interpreted, leading to confusion and inefficiency.
c) Emulation Over Innovation:
While efforts to adopt international best practices are commendable, blindly replicating models from other nations overlooks India’s unique challenges and opportunities, and does not take advantage of India being a late entrant in this sphere – examples include responsible sourcing guidelines and establishment of IIBX, as discussed further below.
d) Apathy Over Action:
The reluctance to address issues such as gold smuggling and regulatory non-compliance perpetuates a cycle of complacency, inhibiting meaningful reforms and progress.
A Call for Change
To chart a new course for India’s gold industry, bold steps are imperative:
1) Define Clear Objectives:
Establish a unified vision for the gold industry, outlining realistic goals and strategies to drive sustainable growth and development.
For example, are we worried about gold imports due to their negative effects on our FX position? Or, do we like gold imports as they allow masses to meet their cultural and investment objectives; allow jewelry manufacturers and exporters easy availability of their raw material; and provide a solid base to our currency as a fall-back option during difficult periods?
2) Streamline Policy Framework:
Consolidate disparate regulations into a coherent framework that fosters transparency, accountability, and ease of compliance.
Is there a merit in identifying a single government or semi-government entity that would be responsible for creating India’s unified gold policy, its implementation, and its regulation, which in turn could interact internally with various ministries, RBI, Customs, and any other Authority before finalizing its actions? Given the size and importance of the industry, could there be a Gold Policy Advisor to the Finance Minister for ensuring a streamlined approach?
3) Foster Innovation:
Encourage experimentation and innovation within the industry, leveraging India's technological prowess to create cutting-edge solutions tailored to its unique needs.
a) India used the model of China (Shanghai Gold Exchange) and Turkey (Borsa Istanbul) to create an infrastructure in GIFT City via IIBX. While IIBX is trying its best to come out with products & services of relevance to the industry, is there a re-thinking required given that the concept of an Exchange itself is outdated now?
Today, technology allows us to create a single digital platform (using technology such as Blockchain) for an OTC market like ours that could be used pan-India (and not just one city), with Spot and Forward features (unlike a fixed contract on an Exchange), and be fully fungible across India & transparent at the same time, with full audit trail. Such a platform could unify the entire Indian gold market-place and reflect a single consolidated large market, making it easier for banks and other counterparties in the process and accruing benefits to the industry.
It could also allow unified regulatory monitoring and generate data at the click of a button. Further, it could lead to development of products & services especially suited to this industry and allow policy-makers a lot of futuristic flexibilities with all the information available at a glance.
Further, such a platform could allow a change in the way we implement gold market-making and collection of customs duty and taxes, and the timing thereof. For example, fixing of gold price and delivery of physical gold are two different transactions which may or may not be related, and therefore should be delinked – duties and taxes need to be collected at the time of delivery.
b) Alternatively, have we thought about using the immense network of State Bank of India (SBI) for creating a unique bullion banking infrastructure in the country?
c) Or, have we thought about using RBI’s latent physical gold in India to create a domestic gold loan market that would reduce reliance on overseas markets and help RBI earn a decent return to cover the cost of storage, security and insurance of this physical gold without losing title over this gold?
4) Empower Regulatory Oversight:
Bolster regulatory mechanisms to combat illicit activities and ensure responsible sourcing practices, safeguarding the integrity of the gold market.
a) Technology allows us to do away with cash transactions (for both sales and purchases) in this industry that could save the regulators a lot of hassles and help cleanse the market. Are we ready to take this difficult step? This author has previously recommended a modus operandi – refer the article “Not All Gold Actually Glitters” in The Economic Times dated 16th March 2024 (https://m.economictimes.com/opinion/et-commentary/not-all-gold-actually-glitters/articleshow/108532144.cms).
b) Dore (raw gold) imports are allowed in India, and rightly so if we have to develop the gold refinery segment for whom this is an essential feedstock. However, with Dore imports comes the necessity of having a comprehensive regulatory and governance framework. And, as a country, we do not even have our own responsible sourcing guidelines in place and it is left for Dore importers to self-regulate by following another international (OECD’s) guideline with no checks and balances - there is no ownership as to which Authority will be responsible for its execution. And execution is key in such matters.
Alternatively, we need to re-think whether gold refineries are indeed required in our country – does it benefit the industry as a whole? Do benefits get passed on to end-consumers? Or, do we just want the benefit for a few large groups involved in gold refining? Does it make sense to put the country’s reputation at stake for these relatively small monetary benefits to a few? What if the world stops buying Indian jewelry due to doubts over whether responsibly sourced gold was used in jewelry manufacturing?
5) Embrace Futuristic Solutions
Harness technology to revolutionize gold industry, creating digital platforms that enhance efficiency and serve genuine needs of the industry as well as retail investors.
a) For example, we could create a Gold Clearing Mechanism in India by allowing the concept of Gold (XAU) accounts (similar to foreign currency accounts) and benefit industry players and masses by enabling instant transfer of ounces or grams (same way as RTGS and NEFT are used for Rupee transfers). This digital mechanism (made in India) could be made international over a period of time and serve as India’s contribution to global gold industry.
b) Further, these same platforms could be integrated and enhanced to include retail dealings, thereby allowing crores of people an alternative to invest in digital gold (backed by physical gold and redeemable pan India in any form – bars, coins, jewelry) through a regulated platform, enable borrowings against gold without losing value of gold, and in future serve in gold mobilisation efforts.
Conclusion
India's gold industry stands at a crossroads, poised for transformation and renewal. By addressing the shortcomings of its current policy framework and embracing a forward-thinking approach, India can unlock the full potential of its gold market, securing its position as a global leader in the industry. The time for action is now - together, let us propel India's gold policy into the future, leaving backwardation behind.
Source: https://www.businesstoday.in