Developing Infrastructures in the Gold Value Chain

Nirupama Soundararajan & Arindam Goswami Pahle India Foundation

The first step to a comprehensive gold policy is to define gold. The next step is to concentrate on upscaling existing infrastructure and creating new infrastructure to support the gold ecosystem. The gold value chain in India can be divided into three broad heads - procurement (which involves lease and financing), domestic trading, and storage and distribution. Currently, the leasing and financing avenues for gold business are limited, trading is primarily carried outside the formal financial system, and storage and distributary networks are mostly rickety. Hence to create a robust gold ecosystem in the country, it is important that the troika of procurement, trade and storage be developed and are at their functional best.

Since India has traditionally been an import dependent economy when it comes to gold, one of the major challenges has been procurement. Currently, gold is imported by nominated banks and nominated agencies, although majority of the import business is concentrated amongst banks. Besides import, banks also finance the gold business through GML, trade financing, and working capital requirements. Despite the key role that banks play in the trade of gold, they do not consider gold as their mainstay business. Infact banks consider gold to be a burden on their core banking activities. Banks are apprehensive (or even averse in many cases) to doing business in gold for broadly two reasons. First, they are wary of the lack of transparency in the business, particularly since most of the gold business is conducted over the counter. Second, many have confessed that they lack the necessary expertise and proficiency to carry out gold business. Hence, our first recommendation is that RBI allows for a special category of banks known as “bullion banks” to be set up in India under the differentiated banking licence. We also recommend that these bullion bank licences are not restricted to existing commercial banks alone, but are also extended to other financial sector participants who understand the gold business. Bullion banks are a tried and tested method of banking, commonly followed internationally. India can follow suit and set up this part of the financial infrastructure that can undertake activities such as buying, selling, leasing, financing, re-financing, bullion investment, and several monetisation schemes.

While bullion banks will help bring transparency in gold procurement, it will not necessarily help in reducing the OTC trade. This means that most of the trade is kept out of the formal financial system with significant variations in the price and quality of gold across channels and points of sales. Global experiences show that setting up a bullion spot exchange can align the business of gold with that of financial market. A spot exchange can further help in reducing disparity in price and quality. Two prominent examples are that of China and Turkey which successfully manged to streamline their gold business by setting up spot exchanges. The announcement for setting up of a Gold Spot Exchange has already been made in the Union Budget of 2018-19. What remains is for a comprehensive regulatory framework for a spot exchange to be set up.

A recent committee under the Chairmanship of Prof. Ramesh Chand, on the integration of spot and future markets has recommended that the gold spot exchange be regulated by SEBI. While SEBI may seem like an appropriate choice, we believe that SEBI does not have the necessary wherewithal to deal with spot transactions.  We recommend that the gold spot exchange be set up under a separate statutory act and under a separate regulator (a Gold Board) with appropriate directives and guidelines for undertaking spot trading. Any spot exchange and its regulatory framework must be befitting of the size of the gold market and the number of prospective participants on the exchange. Such an exchange will integrate the market, enhance transparency in pricing, improve standardisation in quality, and most importantly create a separate mechanism for trading bullion differently from agricultural products.

Having planned for suitable infrastructure for procurement and trading of gold, one naturally turns to storage of gold. At present, bullion vaulting in India is not quite regulated. Recently, SEBI has directed the commodity derivatives exchanges trading in bullion to register vaults used by them and adhere to basic vaulting guidelines. Although this is a smart move by SEBI to ensure standards in vaulting, in the absence of any real regulatory authority and rigid compliance mechanism, these frameworks are only ‘second best’ alternatives when compared to international vaulting standards. Moreover, this surrogate regulatory system extends only up to vaults under exchanges but fails to govern those used by banks, bullion depositing NBFCs, asset management companies and other financial institutions dealing in bullion.

Currently, warehousing in India is regulated by the Warehouse Development and Regulatory Authority of India (WDRAI), but is limited to the accreditation and oversight of only notified agricultural and horticultural commodities, and only those that wish to issue warehouse trading receipts. Warehousing, or vaulting of gold cannot be dealt with similarly. Vaults are an integral part of the financial chain. Hence, we recommend that WDRAI extends its regulatory outreach to vaults storing gold and other precious metals. This single move is expected to benefit the entire gold ecosystem as it will ensure supply of standardised gold in the country. We also recommend that unlike for agricultural and horticultural commodities, accreditation of all gold vaults must be made compulsory.  Gold vaults will also lay the foundation for digital gold.

Disclaimer: Views are personal and not the views of the publisher.