BIS - Mr. Reddy discusses gold banking in India

Mr. Reddy discusses gold banking in India
Address by the Deputy Governor of the Reserve Bank of India, Dr. Y.V. Reddy,
at the World Gold Council Conference held in New Delhi on 02/08/97.


"(i) Let me summarise the arguments of aggressive liberalisers.

- The gold industry, employing goldsmiths numbering about five lakhs, involving an annual turnover of about Rs.25,000 crore, is kept out of any serious consideration in the current reform process. This reflects continuation of a gold-control mindset and the identification of all import, sale or use of gold with black money. Consequently, gold industry exporters of jewellery and genuine purchasers of gold jewellery continue to suffer.

- On account of the present policy, the purchaser of gold jewellery pays a higher price of about Rs.3,000 crore every year because of the “hawala” premium, etc. In percentage terms, at wholesale level, it is an extra 17 per cent. Also, because of lack of consumer protection, and improper certification of quality, the purchaser loses about Rs.4,000 crore each year.

- The present gold policy shows anti-rural bias. The real purchaser of gold is typically a peasant. Close to seventy per cent of gold jewellery is sold in rural areas and most of gold sales are by way of jewellery. To quote Professor Jeffrey A. Franks, “holding gold has in fact often in history served, from France to India, as the only way the peasant can protect himself against inflation and the vicissitudes of politics”.

- Similarly, there is a gender bias, since most of the jewellery is sought by women. While macho consumer durable components are imported and their production or even consumption financed, a non-depreciating asset like gold is discriminated against. It makes no sense to constrain the demand for “a multi-purpose indestructible asset” like gold or gold jewellery, which is a lifetime asset, a hedge against inflation, a source of liquidity and a preferred form of saving.

- From a fiscal point of view, the NRI route generated about Rs.500 crore towards customs in a year. The “officialising” of gold import by liberal import of gold will give Rs.250 crore per annum more towards customs, with duties at the same rate as for NRIs. Further, if gold is imported freely under OGL, gold trade down the line becomes traceable and will provide sales tax to State Governments and octroi to local bodies.

- From a trade policy point of view, the existing restrictions on gold jewellery-producing units like EOUs constrain the participants in the export market and hamper export growth. Free import under OGL and free export are pre-conditions for capturing world markets - as is evident from the Turkish experience.

- Some advocate free import of gold or import under OGL on the ground that there may be a fall in reserves and a desirable impact on the exchange rate. However, most argue that there will be only “officialising” of gold import and use of foreign exchange under hawala, resulting in no net loss of reserves. In fact, once gold jewellery exports pick up, consequent upon gold-import liberalisation, there will be a positive impact on the trade balance.

- There is no way of getting rid of or at least drastically reducing the hawala market in foreign exchange, so harmful to the social and moral fabric of India, unless gold import is freed and the scope for gold smuggling reduced.

- As pointed out by the Committee on Capital Account Convertibility, a pre-condition for further reforms in the external sector is free import of gold.

- Finally, while bank credit is available for import, domestic production or processing and easy acquisition or consumption of luxury goods, no such bank credit is available for gold and gold jewellery employing half a million and providing first-rate security for banks. In fact, the only way of penetrating the informal credit sector without generating non-performing assets is encouraging the flow of bank credit against gold and silver without reference to enduse.

(ii) The cautious liberalisers avoid the subject of liberal bank credit or regulating the gold market altogether, but concentrate on possible balance of payments impact. Hence, they advocate limited import through designated agencies to meet both exporters and domestic industry.

(iii) The no-changers feel that the existing import regime is foreign exchange neutral; and existing policy is a reluctant admission of our incapacity to change the mindset of Indians who are wasting their savings on gold. There is no need to assist or develop this “unproductive” sector or activity.

(iv) There is little support for a total roll-back of policy. There was, however, a suggestion in the context of an analysis of the Report on Capital Account Convertibility in the Economic and Political Weekly (EPW, June 1997). This article reiterated the possible impact of liberalisation of gold import on domestic savings in an adverse way; on diversion of productive resources into unproductive channels; on aiding the process of tax-evasion and hoarding of incomes and assets. Having expressed this, the article states, and I quote, “a more viable policy from the point of healthy and egalitarian development was to recommend the banning of gold imports (other than for jewellery exports and for industrial use), and strict enforcement measures against smuggling”."

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"...Third, in regard to development of gold market, the establishment of a Gold Exchange would help in efficient price discovery and emergence of healthy and transparent practices in the market. The basic framework for such an exchange already exists with 13 banks active in import of precious metals. Five of them have launched the Gold Deposit Scheme also. They are exploring possibilities of introducing ‘paper gold’ products like Gold Accumulation Plans. These banks are fully authorised to sell/lease gold to the market players. They can also enter into forward contracts in a limited way. A committee set up by the RBI has studied the feasibility of introducing Futures Trading in Gold and this is being examined by the Forward Markets Commission. Once the banks start trading among themselves, with MMTC, STC and also with big traders according to the demand/supply dynamics, a formal move towards a Gold Exchange is appropriate. They can even use the infrastructure available with an existing stock exchange like National Stock Exchange (NSE) for this purpose.

Fourth, as part of the positive approach to consumers, the present initiatives by BIS may be supported, strengthened for improvement, reviewed and further measures considered. For example, several banks and other institutions, which are currently importing gold in large measures, could consider establishing a Gold Market Development Agency as a voluntary self regulatory organisation with participation from gold trade and BIS to devise mechanisms by which the efficiency of the market and the integrity of the products are ensured and augmented. For example, banks can play a role by prescribing different margins for loans extended against the pledge of gold with hallmark and those without. Similarly, the banks could take into account, the practice of issuing Gold Content Guarantee Certificates by the gold jewellers while extending credit. This would also help banks in making proper assessment of the inventories of the traders..."


Source: http://www.bis.org/review/r970829a.pdf?frames=0