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Gold Digger Government

In this week's FinMail, we take a look at the framework that was recently approved by SEBI for the creation of a Gold Exchange in India. We also understand the EGR that is going to be traded at the Gold Exchange.

The Story

On September 28, 2021, SEBI approved the framework for setting up Gold Exchange/s in India. This comes after the government showed intent to establish a system of regulated gold exchanges in the country in the budget speech of 2018-19. FM Nirmala Sitharaman in this year's budget speech announced that SEBI will be the regulator of the same and Warehousing Development and Regulatory Authority (WDRA) would be set up to store, transport, and deal in gold and strengthen the ecosystem.

You might be wondering that do we even need this? In that case, let us tell you that currently in India, Gold is only traded in futures contracts (in the form of derivatives and not exactly as Gold itself) which is not the case with other countries like China that have spot exchange facilities for Gold. The absence of spot exchange in India means that we cannot buy or sell gold as a security on the exchanges. Well, yes, we do have Gold Mutual Funds/ETFs and Gold Bonds but you see, that is exactly the case, we have to combine Gold with another financial structure like ETF, Mutual Fund, Bonds, etc. We aren't enabled with a system that allows us to directly trade Gold at a price that is 'real-time' & 'on the spot'.

And that is what the Government & SEBI wants to change and also solve much bigger problems by introducing Gold Exchange and the EGRs (Electronic Gold Receipts).

So what are these problems? And how exactly it will be solved? What is this framework? And is there something we are unable to see? You know you have come to the right place for the answers. To Chaliye Shuru Karte Hai... (No, guruji was not involved in writing this FinMail)

Before we understand the new framework, let's understand the problem that it aims to solve.

The Problem of Price Discovery of Gold

India is the second-largest consumer of Gold in the world only after China. Our domestic demand for gold is about 800-900 tonnes annually and despite being one of the largest consumers of Gold, we as a country don't really have a voice in determining the Price of the Gold. India has always been the 'Price Taker' of the gold even when it has the order volume of being a 'Price Maker'. So at the current junction, India as a country has no influence in setting the price of the Shining Metal. And that has been a problem for the domestic investors who trade and invest in Gold. The Problem of Price Discovery. But hey, what exactly is Price Discovery and Spot Price?

Spot Price is referred to as the current price of any asset (currency, commodity, financial security, etc.) for which it is available to buy as well as to sell at the current point of time. So if you ask a price of the asset like, "Tell me the price if I want to buy/sell this right here, right now." then you are basically asking for the Spot Price of the Asset. You can also refer to Spot Price as "On the Spot" Price.

Price Discovery is the process of... well, discovering the price, generally of an asset. But the explanation doesn't justify the complex process. Price Discovery includes the calculation of various factors to arrive at a common price point. It factors in the demand & supply (current as well as future's), economic & political environment, risk, sentiment, etc. to arrive at an equilibrium price which the buyer and the seller agree to transact.

And in India, we have the same problem. Let's understand how.

Currently, the price discovery of gold in India is dependent on the International Price of Gold. The spot price of Gold in India is affected by a series of global factors. We use the spot price of gold in the London Bullion Exchange for determining the base price of the Gold, the price at which we import; also referred to as the International Price of Gold.

As the gold is imported to India, there are Import Duties, Shipping Costs, and other related charges that are added to the base price. International Gold is denoted in $USD, so the USD-INR exchange rate also comes into the picture and every factor that affect the currency rate also has its impact on the price of gold in India.

And this is where it gets interesting. India has no exchange to determine the gold rates as per the market forces. The Indian Bullion Jewellers Association (IBJA) determines the gold price in India after inviting bids from various gold dealers and averaging the price at which they are ready to buy/sell their gold.

So as you can see, the price discovery of gold is a complex process and very much dependant on the International Price of Gold. The planned Gold Exchange is expected to solve all the hassle and provide better transparency and better price discovery of Gold in India. It is expected that having our own exchange to determine the local prices of gold will ensure that both the buyers & sellers pay the spot/actual price of the gold and not the one that is derived from International Rate. The plan is also to emerge as a global price setter in the future.

The Solution

Setting up a Gold Exchange for Spot Gold Trading. Simple! Having our own gold exchange will help create an ecosystem of trading and physical delivery of Gold. The Gold exchange will help in the efficient and transparent discovery of Spot Gold Price, increase Retail Participation in trading gold, and hence provide better integration of gold with the financial markets.

How exactly will the Gold trading happen on the Gold Exchange?

We cannot exactly trade Physical Gold on the exchange but you know, innovation combined with technology and intelligence can make wonders happen. The spot trading of gold will be enabled through EGRs (Electronic Gold Receipts) that are backed by actual physical gold. These EGRs will be recognised as "Securities" under the regulations of SEBI and hence it will carry all the features like any Financial Security and will be traded and settled like any other security on the exchange. So here is how this happens

Step 1:- Physical Gold is deposited in Vaults recognized by SEBI as 'Vault Managers' - an entity that will be registered and regulated by SEBI, responsible for the storage & conversion of the Physical Gold. The Gold Depositor will get an EGR against the Gold Deposit made by them. So for example, if a person/entity deposits 10gms of gold, they will get an EGR that says that they hold 10 gms of Gold.

Step 2:- These EGRs can be traded like any other security with anyone on the exchange and hence the buying and selling can be done. They can be settled in cash as they carry perpetual validity and hence can be traded forever without redeeming it for gold. The holder that holds the EGR, in the end, is considered as the end owner and if they want to get Physical Delivery of Gold, that's where Step 3 comes in.

Step 3:- These EGRs can also be converted into Physical Gold. One needs to just visit the recognized Gold and submit these EGRs. The units of gold would be handed over to the EGR holder as per the holdings shown in the EGR. The EGR then becomes invalid and cannot be reused to get gold.

Now the salient feature of an EGR is that you can submit those EGRs and get Physical Gold from anywhere in India where the Recognised Vault is present. And there are other benefits like tradeability, safety & security, and the liquidity that it will provide to the Gold Market.

So that is how SEBI plans to introduce first of its kind in India - Gold Exchange. It would provide transparency, liquidity, and better price discovery of Gold in India.

"The Gold exchange will bring a single market in the country with a uniform price," said Ashish Pethe, Chairman, All India Gem & Jewellery Domestic Council (GJC)

"You will have certified pure material. Apart from purity, payments too will be guaranteed" said Surendra Mehta, national secretary of IBJA. But he is of the opinion that it is unlikely that the Gold Exchange would enable India as the price setter of Gold. "Price Discovery can happen only if there is a two-way trade. But India only imports Gold and doesn't export it."

India currently has Gold ETFs, Digital Gold, Sovereign Gold Bonds as Gold Backed Assets that are available for the retail investor to invest/trade in. And looking at the framework, it sure looks like that EGRs would also be a product that would invite Retail Investors.

But is the government attempting to hit two birds with a stone here? Let's just discuss it.

The Unseen:- A Perspective

Whenever there's a Gold Scheme that is being promoted by the government, there is always a need to put on the lenses to see what the naked eye couldn't. Such lens often provides a perspective that could unveil the naked truth behind the curtains. History says that the government (any ruling government) has made numerous attempts to unearth the gold that has been lying in the Indian Households. Be it the Gold Monetisation Scheme, Gold Metal Loan, Gold Savings Account, the government tries to influence the retail investors by providing them the chance to monetise their idle gold and in such an attempt, bring accountability of the unaccounted gold. Through initiatives like SGB or Digital Gold, the government tries to shift the gold demand to products that has accountability.

As per the government estimates, around 23000-24000 tonnes of gold lies unutilised as deposits and jewelry with Indian households and religious institutions. And a lot of black money is turned into 'yellow' to save from the government's eyes and this is what has been like a thorn in the eye for the government. And if we look at the Gold Exchange & EGRs from this perspective, it sure feels like yet another attempt to dig gold records from the Indian Households. Sure it can be an instinct from our end and not an actual attempt but you never know. What remains to see is how the public at large feels about it. That is it for this week's FinMail.


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