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 am thankful to the World Gold Council for inviting me to participate in this
Conference. It is unusual for the organisers to seek the same speaker and even more unusual for
the speaker to accept such an invitation within a span of nine months. That happens in academic
circles. It is of course, routine in the Toast Masters Club, of which I was a member decades ago.
But, this is a gathering of hard-headed finance and business people. I presume that the organisers
felt that I should be called upon to squarely address the issues that I raised in the last meeting, in
a somewhat less inconclusive manner this time. Well, it should be possible to address these
issues with a little more confidence now, since the last conference has generated pretty
well-informed and wide-ranging debate on most of the issues posed.
Today, I will briefly recall the issues that I had posed in November last. We could
trace policy developments since then. I would also share with you the response we received on
the subject, not only from intellectual circles and the media but also through letters addressed to
the Government and the Reserve Bank of India (RBI) - from people in many walks of life.
Against this background, and keeping in view the recent developments in economic reform, it is
possible to examine the rationale for a New Gold Policy (NGP) at this juncture. The possible
objectives and the immediate tasks of an NGP need our attention. If some changes in policy
towards NGP are considered necessary, the role of the RBI, banks, government and
industry/trade would have to be redefined and re-oriented. I will elaborate on the re-orientation.
In my normal style, I will conclude with a set of issues. Deliberately, I am avoiding going into
details of gold banking since these aspects will be elaborated by Mrs. Usha Thorat, who is one of
our resident experts on gold in the RBI.
Issues: A Recall
The issues raised in the last meeting related to demand, supply and use of gold.
On the demand side, the need for and the effectiveness of restricting demand were the main
concerns. On the supply side, limits to domestic production and the implications of import
through various channels were touched upon. The fiscal dimensions, trade policy implications,
balance of payments (BOP) impact and the desirability of restricting gold import to corporates
or banks were also flagged. The role of the RBI in gold policy, sequencing of changes in such a
policy and finally the link with capital account convertibility were flagged for further debate.
As you are aware, many of these issues have been debated since then, and there has been policy
response also.
Policy Response: A Summary
We have made some progress in liberalising gold policy since we met last. The
policy on gold import has been further relaxed and non-resident Indians (NRIs) are allowed to
import 10 kgs of gold, against 5 kgs allowed previously. The EXIM policy for 1997-2002 has
been modified and now, in addition to the existing canalising agencies, the RBI will be
authorising banks to act as nominated agencies for importing gold into the country under various
schemes viz., NRI, SIL and export replenishment/loans, etc. The Tarapore Committee on Capital
Account Convertibility has submitted its report and has made wide-ranging recommendations
relating to gold, including a more liberal import policy for domestic consumption. The RBI has
issued guidelines to banks to apply to it for becoming nominated agencies, and the first set of
applications will be considered shortly. In the meantime, the customs have also modified the
procedures for the import of gold - no longer requiring banks to be totally accountable for export
obligations of the exporters. The Standing Committee on Gold and Precious Metals in the RBI
(Subrahmanyam Committee) has been expanded to include representatives of the Ministries of
Finance and Commerce. The Committee is more active now in rendering advice to the RBI and
the Government.
General Response: A Review
The general response to the issues raised in the previous seminar can be described
as one dominated by aggressive liberalisers, some advocating caution, only a few favouring no
change in the existing policy and virtually none seeking total roll-back of the policy. There has
been no mention of the mobilisation of idle gold for productive purposes or the establishment of
a Gold Bank to raise resources.
(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".
Rationale for New Gold Policy Now
Responses to the issues raised by me last year thus show a distinct preference for
an NGP. It is possible to highlight the important reasons for a re-look at the existing gold policy.
Firstly, it is argued that import or use of gold should be discouraged since it
affects domestic savings adversely and implies diversion of resources for unproductive purposes.
In reality, our household savings, unlike government savings, have been increasing since
independence, while gold was, in spite of the policy, being imported, traded and used. The
diversion of savings to unproductive purposes did not happen in the household sector. Further,
the idea of mobilisation of resources for productive purposes as defined by planners has yielded
place to a slightly different form of policy management of disposition of resources under the
post-reform era. Now, even depreciating luxury goods are produced and traded in our economy.
Why discriminate against gold?
Secondly, it is also held that we should not waste scarce foreign exchange on
unproductive purposes. With current account convertibility and a market-determined exchange
rate, it is not appropriate to place a premium on foreign exchange. Further, the recent
liberalisation of imports through the NRI and SIL route has shown that, in reality, there is no
adverse impact of a liberalised gold import. In fact, this recent experience should provide reason
enough for a review now, with a view to liberalising further.
Thirdly, it is felt that gold is an important instrument for black money deals and
hence restrictions on gold amount to restrictions on black money. Since gold is not the only
instrument of black money deals, making gold availability difficult will not deter either
generation of black money, or its disposition in many ways, including illegal gold. In any case,
with the reduction of income tax rates and the launch of the Voluntary Disclosure Scheme in the
current year, the fiscal stance is clear - remove incentives for generating black money. Hence,
gold policy as an important instrument of anti-black money policy loses its significance, in view
of the recent Budget.
Fourthly, international experience, especially with Turkey, where conditions are
similar, has shown that liberal imports and organised trade in gold benefits the economy,
including the external sector. Also, our neighbours in the SAARC region have liberalised and
officialised gold imports at nominal duties. These developments make it imperative that we
review our policies urgently.
Finally, gold plays an important role in our external trade (next only to oil) and in
the domestic economy. The reform process would be incomplete without a review and update of
the gold policy.
Objectives and Tasks of a New Gold Policy
What should be the possible objectives of an NGP? The review of our policy so
far and the rationale for an NGP that we considered indicate clearly the desirable objectives of
an NGP. The major objectives should perhaps be to:
- recognise the importance of gold in the Indian economic system and enable gold
to play a transparent and positive role in the industrial development, employment
and export sectors of the economy,
- ensure orderly development of a gold-related industry in India in terms of
physical standards and consumer protection,
- create and nurture appropriate official regulatory framework and self-regulatory
trade bodies,
- exploit the scope for generating revenues to the central, state and local
governments,
- align the regulatory framework and institutional capabilities in the financial
sector - especially banking sector - to enable the above, including gold banking,
and
- enable fuller integration of gold with other areas of the domestic economy and
closer integration with the world gold economy, consistent with our economic
reform policies.
If we accept the above objectives of an NGP, four broad sets of measures may
need our attention now. These are (i) gold and trade policy (ii) regulation and development of
domestic trading, including quality markup (iii) bank financing for import, export and domestic
activities and (iv) gold banking.
First, on gold and trade policy, the broad thrust has to be liberalisation of import
and export, but there are many options in this regard, and these need to be debated. First, place
gold under OGL. This would be an ideal situation for free trade and freely tradeable good.
However, as an immediate measure, some scepticism could be expressed. Gold has some
characteristics of currency, a financial asset and has quasi-foreign exchange attributes. However,
free import by members of the organised bullion market or designated agencies should serve the
purpose, with some scope for regulation. Import of gold through designated agencies including
banks would help regulate the gold market, besides assuring the quality of gold and bringing
more transparency in prices. The advantage of restricting import of gold to designated agencies
is that the regulators can fix monetary limits on import during the transition. The domestic
transactions of gold imported through the designated agencies could be more easily tracked and
would be channelled for making jewellery for domestic use or export. This would also boost
exports substantially. On this logic, it will be necessary to discourage liberalised import through
NRIs. However, it is possible to charge less import duty when designated agencies import, to
discourage the NRI route. In any case, nominal import duty is a pre-condition for liberalised
imports. Incidentally, under the liberalised regime, the sale of gold by designated agencies has to
be freely permitted to domestic jewellery units. Also, the stipulation of payment of duty in
foreign exchange may have to be dispensed with in view of the avoidable irritants, the
undermining of domestic currency and market-determined exchange rate.
Second, impetus to active domestic trading in gold is a logical consequence of an
NGP. Currently, the industry is fragmented. It will be essential to tackle major operational issues
required to give a fillip to the gold market, such as the development of refining capacity,
accredition of refineries and the introduction of the system of hallmarking as a consumer
protection and export promotion measure. Further, serial number, fineness and assay mark of the
melter and assayer should be found stamped on bars. We may have to allow foreign companies
with expertise in this area to set up shop in India. The melters and refiners, both from within and
outside India may have to be permitted based on net worth, turnover, etc. Perhaps we have a lot
of catching up to do.
Third, it may be necessary to recognise financing as an important policy
component of developing the gold market. As would be explained later, the legal and
institutional framework is available.
Finally, the development of gold banking will be derived from the policy stance.
On this subject, I expect the deliberations in this conference to throw up some ideas.
The Role of the Reserve Bank of India
Central banks the world over have a special concern and role in gold economy.
The RBI is no exception. Broadly speaking, the role of the RBI spans five areas.
First, and very obvious, is the management of gold reserves. Since October 1990,
the Bank's gold holdings have been valued on the basis of international market prices. We
recognise the price risk on the gold holdings and have considered the use of gold options and
futures to hedge our risk. However, the RBI Act in its present form does not have enabling
provisions. There is also a view that exemption notification by the Government would be
required under Section 27 of the Forward Contracts (Regulations) Act to enable the RBI to enter
into gold - currency swaps.
Second, the RBI had played an active part in the local bullion market. The RBI
had, in the past, close links with Bullion Market Association, and the RBI's nominee was a
member. In the 1970s, gold sale was organised domestically by the RBI, even as it continued its
interest in the study of gold and precious metals, monitoring prices, trade, etc., and constantly
advised the Government on policies. The RBI in future under the NGP, could play a role similar
to the Bank of England in the bullion market.
Third, the licensing of import of gold and silver bullion was for a long time a
function of the RBI and not of the Import Trade Control. It was only through the amendment to
the Foreign Exchange Regulation Act, 1973 in 1992 that the import of gold/silver and the export
of gold, jewellery and precious stones ceased to be regulated by the RBI. Now, policy with
regard to the import and export of gold is under the purview of EXIM policy. However, as per
the recent EXIM Policy, the RBI can designate an agency to import gold for selling it to
exporters only.
Fourth, in terms of Section 6 of the Banking Regulation Act, 1949, in addition to
the business of banking, a banking company may engage in the buying, selling and dealing in
bullion and specie. In fact, the Act allows banks to trade in bullion. Banks extend credit against
gold. The regulatory role of RBI arises out of its supervisory functions over banks.
Fifth, the RBI has and continues to play its rightful role in influencing the gold
policy in the country. We have in fact established a framework for ongoing review of policy in
gold. We established a Standing Committee on Gold and other Precious Metals in 1992 which
has since been enlarged and activated in 1997. The Committee is also addressing issues relating
to the development of the gold market and gold based instruments, with providing a significant
boost to jewellery export being one of its objectives. We expect this committee to take an active
interest in matters relating to gold banking also.
The Role of Government
I have alluded, earlier today, to the need for an amendment to the RBI Act and
also to issuance of notification by the Government under Section 27 of the Forward Contracts
(Regulation) Act, 1954. These measures are needed to enable the RBI and banks to enter into
derivative contracts in gold. Further, it is not clear whether gold-denominated certificates and
other gold-related products would be deemed to be a security in terms of Securities Contracts
(Regulation) Act. There are also wide-ranging issues related to taxation. In the European
Community, transactions in gold are subject to VAT at rates which vary from country to
country. In some countries, gold is subject to sales tax as well. In the UK, there is a formal
agreement between the Commissioner of Customs and Excise and the London Bullion Market,
on matters relating to tax treatment, and no doubt with the support of the Bank of England. The
Government's role is critical in creating an enabling environment, especially through changes in
the legal framework.
The Role of Trade and Industry
In the early part of this century, there existed an active gold market in India - both
physical and financial - and gold options and futures were actively traded in the Bombay Bullion
Exchange.
It is possible to revive this market now. Futures trading is already active in other
commodities like pepper, etc. and perhaps there is no reason for disallowing gold to be traded
again, though under an appropriate regulatory framework. The focus of the regulation could be
to ensure that trading is undertaken within prudential limits and correlated to risk-taking
capacity, to prevent systemic weakness and to induce transparency in trading practices.
We could draw lessons from the British experience. The London Bullion Market
Association has the formal responsibility for the supervision of its wholesale bullion market. The
Bank of England, with assistance from the London Bullion Market Association, has drawn up a
Code of Conduct for the market which covers such matters as confidentiality, market ethics,
inducement and conflicts of interest. It is the responsibility of the Association to monitor its
members' adherence both in letter and in spirit, and bring any breaches to the central bank's
attention. In addition, the Association has taken over the functions previously performed by the
London Gold Market and the London Silver Market in connection with the technical aspects of
deliverable material, the rules governing application for inclusion in the list of acceptable
Melters and Assayers and the codification of market practices as far as clearing and settlement
are concerned.
The Role of Banks
Currently, the role of commercial banks is limited to investment in gold as an
SLR asset and to lend against bullion and specie. As mentioned, banks could play a more active
role in financing gold-related activities. As an immediate measure, perhaps banks may be
(a) permitted to be designated agencies for import, (b) encouraged to lend against gold or silver
jewellery as security up to - say Rs.2 lakh without any stipulation on end-use to help peasants
and penetrate the informal credit sector, (c) advised to devise gold acquisition plans,
(d) permitted to lend liberally to gold jewellery business, and (e) allowed to draw upon
international experience to deal in the gold industry.
Issues
As you would notice, I have not gone into the details of gold banking. Similarly,
on gold policy and capital account convertibility, my distinguished predecessor, friend,
philosopher and guide Dr. Tarapore, will address you later. Deliberately, I have not gone into
the issue of the current price situation of gold or use of gold as reserves by central banks. I feel
that those issues, though of contemporary interest, are not directly relevant.
I am thus, left with issues that flow from my presentation today.
First: what should be the possible objectives of an NGP? And when should we
launch an NGP? Second: is mere liberalisation of import of gold enough of a reform? If not,
what are the other measures? Third: who should be the promoter/regulator for gold trade?
Fourth: what should be the objectives of regulating gold trade? Fifth: what are the measures that
are possible under the existing legal framework? What changes in legal framework are needed to
achieve a globally strategic position for India in world gold economy? Sixth: what should be the
tax regime, since in many countries the tax regime for gold is somewhat special. Seventh: how
soon could the physical facilities, like quality assaying, marking, designs etc. of international
standards be established? What will be the role of foreign investment and technology in this
area? Eighth: how should the banks equip themselves to do gold banking - immediately, with the
present legal and policy frame - and soon, to exploit the opportunities under a possible NGP?
Ninth: and this is critical from the RBI's point of view - what is expected of the RBI in the
context of developing gold banking now, and under a possible NGP?
Let me conclude by thanking the audience for patiently listening to me and
assuring the organisers that we in the RBI are eagerly looking forward to the benefit of
deliberations here.