Why India is not a price-setter in the global gold market

India is a notable global player in many commodities — either as a producer, consumer, importer or exporter. It is the largest producer of milk and pulses, and No 2 in rice, wheat, sugar and cotton. Now, India has emerged the world’s second largest producer of crude steel and the third largest importer and consumer of crude oil, though way behind China in both. Also, we are No 1 importer and consumer of gold.

Yet, India has seldom influenced global commodity prices. It has been a price-taker rather than a setter for most commodities, except perhaps some niche and monopoly products like Basmati rice. India began to rise in the global commodity market especially after well-capitalised national exchanges were established in 2002-03 to promote derivatives trading. Buoyed by the success of the derivatives trading, some enterprising entrepreneurs started to talk about the need to convert India from a price-taker to a setter.

Gold was then the focus and India’s appetite for the yellow metal was ravenous. Imports increased year after year and so did the price of the metal. Double-digit growth in gold prices year-on-year for well over a decade till 2012 led people to imagine that India, as the world’s largest importer/consumer, would be able to set benchmark prices.

But the market conditions were far from conducive. There was utter lack of support on policy, investment or research fronts, and no strategy to achieve the objective was in sight. In retrospect, the talk was more a gimmick to attract market participants than any genuine desire to make India a pivotal player in the world market.

Without doubt, the idea that India should become a price-setter is a grand one. But a look around the world would suggest it is not as simple as some think.

Production or consumption in large quantities alone will not turn a country into a price-setter; same with large import or export. Nor can futures trading volumes. Many conditions need to be met; and, sadly, no one discusses them. No wonder, we are nowhere close to setting global prices in any major commodity, leave alone gold.

Price-setting countries are not just large producers or consumers, importers or exporters, but are an integral part of the global value chain with unrestricted foreign trade, currency remittance facility, high level of quality assurance and a transparent spot market.

For India to become a genuine price-setter, several conditions have to be fulfilled, and many challenges/weaknesses addressed. These include: (1) policy predictability; (2) transparent physical market; (3) robust quality assurance system; (4) infrastructure (both solid and soft); (5) integral part of global value chain; (6) consistently high trading volumes on exchanges; (7) currency convertibility; and (8) strong regulatory oversight

Does gold fit in?

For India and Indians, gold has mythological, historical, economic, social and cultural significance. Its economic significance as a store of value, the financial security it offers and its easy fungibility with cash are well recognised. Gold is usually touted as a commodity in which India can become a price-setter; but it has not happened.

The policy environment for the yellow metal is anything but supportive and predictable. In policymaking circles, gold is seen as a demerit commodity. Domestic economic compulsions, including large and widening CAD (current account deficit) as also revenue considerations, often result in policy changes that adversely impact the market.

A gold import duty, introduced since January 2012, has been hiked from time to time. Duty is calculated on the basis of tariff value that changes perhaps every fortnight depending on global price dynamics.

Policy predictability is critical. We need to create a stable, predictable long-term policy environment for gold, taking into account the interests of all stakeholders. None exists today. For instance, the introduction and withdrawal of the 80:20 (mandatory export of jewellery up to 20 per cent of the gold imported) rule. Such switches more often than not distort the market and create a sense of uncertainty.

The physical market for gold is anything but transparent. Of course, the jewellery trade is getting increasingly organised. Over the last 10-15 years, many jewellery firms have come into the market with diverse geographical presence and large advertising budgets. This is a positive.

But the unorganised market is still large. The traditional family-jeweller has a sizeable clientèle because of his long association with customers, often over generations. The jewellery trade works on trust and relationship; consumers still go to their trusted jeweller, who is usually outside the purview of the formal market. By the very nature of the relationship-based transaction, the purity of the metal is assumed to be ‘what it is said to be’. Often, transactions are in cash.

Apart from the unorganised market of traditional jewellers, there is a grey market for gold that is more distorting for the economy. The grey market usually deals in gold not imported through official channels (unauthorised imports, or smuggling). The grey market means zero transparency in price and purity of goods as well as payment. Its backdoor entry into the market often results in price distortions. Extraordinary measures are necessary to contain the grey market including stricter surveillance and exemplary punishment for offenders.

India’s borders are porous. A huge differential between domestic and overseas prices due to the high rate of Customs duty creates conditions for the grey market to thrive.

In case of official gold imports, it is necessary to establish an audit trail which, among other things, must ascertain the origin (usually in bars), source of payment, disposal of the imported material and conversion into jewellery and eventual consumer purchase. In other words, the gold market needs a system of end-to-end traceability which will enhance transparency and bring in good trading practices even while boosting market confidence. However, the government admits ‘there is no mechanism to measure the demand and sale of gold in domestic market’.

Unfortunately, unaccounted cash is often held in gold given its nature of high value in low volume. From time to time, reports of terror or drug funds moving into gold do the rounds. Traceability systems and audit trails are the way forward. It is indeed a tough call for policymakers if they are serious about ensuring market transparency.

Quality assurance ought to be a key element of the high-value gold market. Strict enforcement of consumer protection laws is necessary. However, under-carating is a widely recognised bane. Consumers would not know whether the jewellery they paid for is made of 22, 18 carat or 14 carat gold; they may be paying for a higher caratage, but receiving lower caratage material.

As part of a robust quality assurance system, Hallmarking should be mandated. Adequate infrastructure (number of assaying and hallmarking centres, geographically well spread) is required. Clear guidelines to deal with cases of breach of rules will help.

On January 15, 2020, the Government notified the ‘Quality Control Order for Mandatory Hallmarking of Gold Jewellery and Gold Artefacts Order, 2020’ mandating hallmarking from January 15, 2021. Only three grades — 14, 18 and 22 carats for gold jewellery and artefacts, as prescribed in Indian Standard IS: 1417: 2016 — can be hallmarked. As on December 25, 2019, 892 Hallmarking and Assaying (A&H) centres had been recognized by BIS. But their average utilisation is less than 50 per cent

As important as physical infrastructure like assaying, transport and vaulting, is soft infrastructure which, covers flow of information, technology infusion and skill development through training. Because the market is still largely unorganised, data capture and broadcast are more anecdotal. Lack of scientifically captured data often provides ‘information arbitrage’ and encourages speculative forces.

Is India part of gold global value chain? Unfortunately, no. Although India is a large importer of the metal, it is strictly not a part of the GVC. Export and import is not free. Import of gold and silver is restricted and can be done only by Nominated Agencies as notified by the RBI (in case of banks) and the Director-General of Foreign Trade (in case of others). Import of gold and silver ‘dore’ is also restricted and can be done only by refiners after obtaining a licence. While India encourages export of value-added gold products such as jewellery, gold export as such — say bars — is not permitted. Even for jewellery, there are value-addition norms.

A handful of entities covering a few commercial banks and State trading agencies is allowed to import gold. The user market has to depend on the import schedule of these agencies. The policy has been made more restrictive in recent times with the withdrawal of import permission to large export trading houses.

There is a contentious issue over Indian entities hedging their gold price risks in international exchanges. The presence of large Indian entities with exposure to the underlying asset — gold — as hedgers in international exchanges has dwindled following RBI’s mandate that the entities hedge their price risk in domestic exchanges. While this may be good for promoting ‘Trade in India’, the absence of large Indian entities in international exchanges does nothing to advance the image and clout of the country in the global marketplace.

Regulatory oversight is another issue. Gold’s regulatory oversight is scattered among several institutions, including mainly the Ministry of Finance (fiscal matters), the Ministry of Commerce (foreign trade policy), the Ministry of Consumer Affairs (quality), the RBI (financial institutions) and SEBI (derivatives trade). Often, a silo approach marks the regulatory oversight. This must change. Much greater coordination and clarity in policymaking, implementation of rules and promotion of gold market are necessary.

In addition to the many pre-requisites mentioned above, a major roadblock to India becoming a global price-setter in gold is currency convertibility . Although perceived to be liberal from a historical perspective, there still are restrictions on remittances from the country and compliance is onerous. The rupee is not convertible on capital account as yet. On current reckoning, the rupee is several years away from becoming convertible on capital account. For India to become a global price setter for gold, there are several ‘necessary’ conditions though these may not be ‘sufficient’. Perception about the nation, ease of doing business, confidence of international financial institutions and investors in the long-term stability and sustainability of business as well as other factors will come into play.

There are those who point to London and New York, where large-scale gold trading takes place, and suggest that India must take a cue by making Mumbai (India’s commercial capital) a gold hub. Lest we forget, London and New York have been financial centres for decades, having been home to and servicing large market participants such as institutional investors, commercial banks, large hedge funds, HNIs and others including globally recognised jewellery stores. There is a lot to learn from the evolution of these cities.

India has a long way to go before being equipped to set global benchmark prices for any key commodity like gold. We have to start working on a strategic time-bound roadmap to address the several pre-requisites. We need to set our house in order first. It is an arduous challenge, but the vision is worth pursuing.

The writer is a policy commentator and commodities market specialist. Views are personal