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The gold standard for gold reserves

The gold standard for gold reserves

April 22, 2019


A comprehensive gold policy, ensuring quality standardisation through Good Delivery Rules in tune with global standards, mandatory hallmarking of jewellery, transparent pricing, institutional enablement for accreditation and regulation of vaults, and well-functioning electronic spot market platforms will reduce gold imports through financialisation, and also boost jewellery exports.


With Rs 51,053 crore of household savings being invested in gold assets as per the National Accounts Statistics (2018), India is the second largest consumer of the gold in the world with an annual average demand of about 732 tonnes during the past three years. Close to 90% of this demand is met through imports, adding to the country’s current account deficit. Gold imports, estimated at $24.7 billion (Q1 to Q3, FY19), accounted for 6.25% of total imports and 17% of total trade deficit, also referred to as gold deficit. This, in turn, adds more to India’s current account deficit, which stood at 2.6% of GDP during the first nine months of 2018-19. On the contrary, China, with a trade surplus of 1.25% of GDP in the last three years, had an average demand of 950 tonnes. Adding to the fact that China’s domestic market capitalisation with all the foreign participation limitations is $8.71 trillion compared with India’s estimated at $2.33 trillion (end-2017), it shows that there is a dire need to financialise the gold-based saving and investment needs by turning them into financial instruments.Being an investment commodity, gold has trivial consumption use, largely owing to its scarcity. This led to a debate around productivity of investments in gold given that, in today’s digitally-connected world, Indian savers have access to far more high-yielding, liquid and low-risk productive equity and debt instruments. Secondly, with lower domestic production/recycling and partially-convertible economy, any spurt in demand for gold puts pressure on forex reserves and hence the commodity markets.


At the same time, Indian households and religious institutions are estimated to be holding about 25,000 tonnes of gold (World Gold Council, 2017)—the largest gold stocks above the ground. It prompts for immediate steps to reduce the import burden through raising domestic supply of gold by promoting mine production and recycling of gold as well as promoting financialisation of gold for investment purposes. The domestic annual mine production of gold in India stood at 2 tonnes compared to 450 tonnes in China, despite the fact that there is an estimated 484 million tonnes of gold ore under resource category (Indian Bureau of Mines, 2018), suggesting the potential for a significant increase in domestic gold production. A friendlier mining policy towards promotion of exploration will go a long way in reducing the import burden and hence the forex outgo.


The other potential way of reducing import dependence and increasing domestic supplies is by recycling the substantial but idle holdings of gold with Indian households and religious institutions through an attractive monetisation scheme. While efforts started two decades ago (the 1999 Gold Deposit Scheme—subsequently the Gold Monetisation Scheme, or GMS, in 2013), monetisation of gold in the country has not yet gained the desired momentum. Policy measures to encourage religious endowments and trusts are critical in converting a large quantity of physical gold held by them into digital/demat format, and should be taken up to facilitate monetisation of gold held by them. Establishing Good Delivery Rules in line with global benchmarks asserting uniform quality standards and transparency with necessary infrastructure and policies are critical in ensuring the trust of the market participants in any gold monetisation measures we take.


As far as Good Delivery Rules are concerned, these were set by the London Bullion Market Association (LBMA) are are widely accepted as the necessary guidance for refiners seeking accreditation and the list of refiners certified by LBMA are known as the ‘good delivery list’. The first London Good Delivery List was set up by the Bank of England in 1750, recognising the refineries that produced mandated standard of gold acceptable to enter London markets. This list eventually became globally-accepted accreditation for wholesale gold bars traded in the bullion market, which is now overseen by LBMA following its setting up in 1987.


At present, there are 68 gold refiners in LBMA’s Good Delivery List across the world. Although 29 of them are in Asia, only one (MMTC-PAMP) such gold refiner is in India; in China, nine such refiners are already operating and more are in the pipeline to be certified. In addition, the Shanghai Gold Exchange (SGE), an electronic spot gold trading platform launched in 2002 by the People’s Bank of China, has also set up ‘standard gold’ rules for domestic refiners that can enter into the SGE-designated vaults. The radical transformation of the Chinese gold ecosystem in the past 15 years was brought about by establishing uniform quality standards and bringing transparency into the gold markets, primarily through SGE. Essential components of LBMA Good Delivery model comprise of establishing accredited refiners (good delivery list); vaults providing secure storage and ensuring the quality of the bars as specified in terms of weight, dimensions, fineness along with serial number marks; governance through compliance panel and physical committee for responsible sourcing of gold ensuring compliance, risk management, transparency, information sharing and business conduct; and connecting to institutions such insurance and secure carrier service providers for ensuring quality and quantity during storage and transit of gold. Implementing Indian Good Delivery standards similar to the above will win the trust of market participants and connect Indian markets with their global counterparts, besides enriching the refining ecosystem. In conjunction with the Good Delivery Rules, it is vital to formulate and implement guidelines for vault accreditation through notifying gold and silver under WDRA. The e-NWRs issued by the vaults under a regulated scenario also provide gold better connect with the financial markets.


Apart from gold bars, standardisation of domestic gold jewellery would have to be mandated through the current hallmarking mechanism, taking a leaf out of the UK markets where jewellery hallmarking is mandatory. Globally, hallmarking is a widely accepted standards system to indicate purity and fineness of gold jewellery, and it aids in effective recycling. While the historical reference to hallmarking of gold jewellery dates as far back as to 13th century, a group of European countries signed the “Vienna Convention on the control of the fineness and the hallmarking of the precious metals” in 1972 introducing the Common Control Mark (CCM) and the member countries accept import of jewellery marked with CCM. India is the fourth-largest exporter of jewellery accounting for about 10% of world jewellery trade. A large potential for exports will open up if India takes measures to become a member of the Vienna Convention. This will significantly expand potential new export destinations for Indian jewellery and help to achieve the target of doubling jewellery exports by 2022.


The third and the most practical strategy to reduce the burden of gold imports is to divert the investment demand for physical gold to paper gold through financial products such as exchange traded funds (ETFs) based on gold futures, sovereign gold bonds and gold savings accounts. Domestic annual investment in physical gold, in the form of bars and coins along with ETFs, during the past five years on an average stood at around 230 tonnes, accounting for about 25% of total gold demand in the country. A substantial part of this investment demand for gold may be diverted to financial products from physical through suitable regulatory and policy measures. In addition to the necessary policy and regulatory measures, there is a need for creating awareness among the gold investors about the merits of investing in financial products over physical gold, such as ease of buying and selling, cost savings on storage, insurance, etc.A comprehensive gold policy, ensuring quality standardisation through Good Delivery Rules in tune with global standards, mandatory hallmarking of jewellery, transparent pricing, institutional enablement for accreditation and regulation of vaults, and well-functioning electronic spot market platforms will not only reduce gold imports through financialisation and monetisation of gold, but will also boost jewellery exports by establishing India as the global benchmark source for standard gold and jewellery, thereby contributing to employment and value addition than just being a forex burden.