Does a gold spot exchange hold much promise?

A gold spot exchange in India, which would usher in a mechanism to ensure safe and transparent gold transactions, has been a long-standing industry demand. With the Securities and Exchange Board of India (Sebi) giving a go-ahead to launch such an exchange, and the NSE, BSE and MCX working towards it, India is now well on its way to establishing a regulated and standardized spot gold trading architecture.

With an annual demand of 800-900 tonnes of gold, India is the world’s second-largest consumer after China, accounting for 11%-12% of the total global gold consumption. However, unlike China, and other key gold market centres such as Turkey, the country lacks a physical gold spot exchange. Gold is vital to India’s economy and culture, but there is no mechanism to standardize its price. The country’s gold ecosystem is beset by challenges such as a lack of quality assurance, price manipulation and high market fragmentation. A gold exchange can fix these issues.

A gold exchange allows spot trading of physical gold represented by electronic gold receipts (EGRs). Investors who intend to trade on the gold exchange must deposit physical gold with a Sebi-accredited vault manager, and receive an EGR in exchange. The EGRs resemble equity shares of a company, with possible denominations designed by the stock exchanges as tradeable quantities to ensure optimal trade and consumption in the trading platform. The deliverable quantity, i.e, the quantity that can be deposited or withdrawn from the vaults would initially be from 100 grams to 1kg with 995 purity or 999 purity.

Since EGRs have perpetual validity, they can be held for as long as one desires. Also, since the physical gold deposited in the vaults is accompanied by a package list/certificate issued by refiners that are approved by accreditation agencies such as LBMA, BIS and the like, the quality and weight is expected to be standard and as per the declaration. Trades will be settled like other securities. The investor can withdraw the gold after surrendering the EGRs.

The system provides high liquidity, except that EGRs can’t be converted until the accumulated gold in the vault reaches deliverable quantity. Investors must pay vault fees, conversion fees, GST on EGR conversion, and other costs. These costs, however, are expected to be more than offset by the potential benefits of the new mechanism.

Currently, the price of gold in India varies from city to city, and different bullion associations charge differently. There is no foolproof method to ensure the weight and purity of gold. Big traders buy gold directly from miners and overseas gold hubs like Dubai. Medium and small jewellers are often forced to rely on large players, which puts them at a price disadvantage. This system is inefficient and raises costs for jewellers as well as the customers.

This is where the spot market comes into play. It uses real time demand-supply data to determine the price of gold. A gold spot exchange will establish a transparent regulatory framework for trading in gold receipts, enabling traders and retail buyers to benefit from uniform, market-determined prices and quality standardization. Since it is controlled by Sebi, the platform inspires trust among investors.

India is heavily dependent on gold imports. As per World Gold Council (WGC), over 2016-2020, imports made up 86% of India’s gold supply, recycling accounted for 13%, and mining for just 1%. India is the world’s largest gold hoarder, with an estimated 25,000 tonnes of the yellow metal stored in its households, lockers and trusts. Once the gold exchange comes, this idle gold can be brought into the financial system. Monetizing and recycling gold will reduce the country’s gold imports and improve its balance of payments.

Individual investors, banks, refiners, bullion traders, jewellers, and retailers are expected to benefit from the spot exchange. EGR will have several advantages over other gold investment options in India, including digital gold, gold ETFs, gold mutual funds, and sovereign gold bonds, in terms of price standardization, liquidity, and physical delivery of gold. Currently, investors who want to hedge their positions have to use complex financial instruments such as futures contracts. Having a spot exchange would allow investors to simply buy or sell gold to protect their positions. Along with providing liquidity, the mechanism offers the benefits of arbitrage.

A strong network of vaults, a clear regulatory architecture, tax incentives, and multi-stakeholder collaboration, as highlighted by the WGC and industry steering committee’s blueprint (2019), are prerequisites for the success of the proposed gold exchange.

Ramkumar K is chief of business and operations, at CDSL.

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