Indian gold-market policy Approach note November 2016

1. Savings or Luxury

The traditional belief about Indian gold demand Demand is rural Rural income is primarily agricultural Consequently monsoons dramatically impact gold demand We have always been aware of how much gold India consumes And we have always known the form in which gold is consumed But do we really know which sections of India consume gold And do we really know why Indians consume gold?

Widely different views on who consumes gold in India today Economic survey of India 2015- 161 The ‘rich’ consume most of the Gold - top 20 per cent of population account for roughly 80 per cent of total consumption NSS 68th survey of consumption patterns in India Gold is more than 1% of monthly consumption only for the 10% richest rural consumers, while it is consistently a larger share of the urban consumers spend GFMS Gold survey 2016 Indian households dependent on agricultural activities contribute to 35% of annual gold demand, and are highly sensitive to monsoons NSE- IFMR survey 2016 Gold is the second largest asset for rural households, comprising 45% of total savings for rural households With increasing urbanization, has the definition of “Rural” changed? 1 2 http://indiabudget.nic.in/es2015-16/echapvol1-06.pdf GFMS Gold survey 2016

Illustrative of FICCI survey2 IFMR research in rural India In addition to consumption, the traditional role of gold as a savings vehicle is clear CONSUMPTION INVESTMENT SAVINGS Illustrative of FICCI survey2 IFMR research in rural India Safe asset 76.62% For adornment 52.54% Save for future 23.05% Consumer surveys vary from gold’s role as luxury or saving but not investment Financial instruments do not feature as a significant tool for investment in rural India 1 2 http://www.gold.org/research/why-india-needs-gold-policy https://www.nseindia.com/research/content/NSE-IFMR_Paper_6.pdf

Sovereign Gold bonds are still in their infancy Whereas there may be an investment benefit, the driver for Gold is not ‘conventional’ investment CONSUMPTION INVESTMENT SAVINGS Gold backed financial products represent only 0.2% of the value of India’s stock of gold Sovereign Gold bonds are still in their infancy Period Bond uptake1 Imports 2 Nov 2015 0.916 77.97 Jan 2016 3.071 42.46 Apr 2016 1.128 40.11 1 2 http://economictimes.indiatimes.com/wealth/invest/how-much-sovereign-gold-bond-issues-have-collected-till-now/articleshow/52584514.cms https://www.gold.org/statistics#group2

Independent of what the policy focus has been, gold has been steadily viewed from a policy perspective as an unproductive asset class Economic survey 2012: “There is scope to discourage unproductive imports, like gold and consumer goods, to restore balance” Economic survey 2016: “Gold is a demerit good. There is a huge subsidy of 25%..about 98% of the subsidy accrues to the better off….” Gold continues to be a strain on current account deficit. Managing gold imports is a challenge due to the difficult tradeoff between controls and smuggling of gold & associated revenue loss

Policy is increasing controls on gold Increased Engagement Restrictions Liberalisation Restrictions/controls 1950 1996 1997 2012 2013 2016 Fully restricted policy Banks freely engage Import of Gold Removal of restrictions on derivatives Decrease imported coins 80:20 introduction and removal Increase in customs duty from 0-4-10% 1% Excise on jewelry

Tax and policy considerations 2.

Government decision making operates at two levels: revenue and policy Taxation: Ministry of Finance GST 1 Budget 2 Determined with inputs from CEA To be decided in November 2016 Will set GST Finance ministry, CEA, Tax research Unit To be decided in January 2017 Will set Customs Duty (determined in part by GST) Policy: Purview of GOI, various bodies Gold policy for India 1 RBI 2 Various dept: DGFT, CBEC, CBDT 3 Multitude of trade bodies No single voice Difficult to please all Export/import Financing Banks vis a vis gold GMS & SGB Export/import Foreign trade Direct taxation Excise https://thelogicalindian.com/news/how-gold-obsessed-is-india-know-the-facts-about-private-gold-why-govt-need-it/ World Gold Council 2015 report http://in.reuters.com/article/india-gold-deposit-bank-interest-idINKBN0O41JP20150519

Taxation: Ministry of Finance Purview of GOI, various bodies What should be the ask? Taxation: Ministry of Finance Alignment with global economy implies high GST on jewelry – being a luxury good and low/nil customs duty on gold – the latter being a financial product This requires determination of Customs duty on Gold (a manufactured financial asset) and Dore (a manufacturing input) This also requires determination of GST on gold (financial product) and then GST on jewelry (Luxury good) Policy: Purview of GOI, various bodies Two way trade in gold (to enable India to productively use its large stock of gold), to enhance Make in India and improve the quality standards of products Commitment to responsible gold standards, international accreditations as opposed to domestic, integrating banking system and easing financial restrictions https://thelogicalindian.com/news/how-gold-obsessed-is-india-know-the-facts-about-private-gold-why-govt-need-it/ World Gold Council 2015 report http://in.reuters.com/article/india-gold-deposit-bank-interest-idINKBN0O41JP20150519

Smuggling is impacted by the total end rate to the customer 1 Smuggling is determined by the overall total rate faced by consumers. 1. Optimal tax setting Smuggling is impacted by the total end rate to the customer Current customs duty is 10.3% GST on jewelry 2 Smuggling can be best tackled by focusing on the end consumer. This is in line with govt current focus via Stricter KYC, raids on black money, AML norms, income tax and PAN 3 As GST increases, the use of jewellery as an inefficient savings vehicle reduces. People use jewellery for luxury consumption, and hence this should attract higher tax Customs duty on imports 4 Low customs duty enables India to move to gold bullion (as opposed to jewellery) for investment. This supports: Increasing dematerial use of gold Make in India for refiners Reduces inefficient excise and customs regulation https://thelogicalindian.com/news/how-gold-obsessed-is-india-know-the-facts-about-private-gold-why-govt-need-it/ World Gold Council 2015 report http://in.reuters.com/article/india-gold-deposit-bank-interest-idINKBN0O41JP20150519

2. Addressing Compliance, Reputation & Integrity Risks Themes Key activities Currently India is not being well served Lack of Anti money laundering (AML) and compliance rules regulating gold / gold Dore import exposes the nation to huge criminal and reputational risk Not all gold imported conforms to verifiable international purity standards “Touch-down” exports of gold jewelry / minted items not only causes harm to nation’s finance but also carries huge reputational risk Mitigating compliance, reputation and integrity risks Banks / Nominated Agencies and Refineries importing Gold/Gold Dore must: Commit to a ‘Responsible Supply Chain’ policy consistent with Annex II of the OECD Due Diligence Guidance for Responsible Supply Chain. Establish a strong system to comply with high standards of Anti Money Laundering (AML) and Combating financing of terrorism (CFT) Ensure that all dealings in their supply chain are transacted with organizations that comply with the LBMA Responsible Gold Guidance and are accredited as such by the LBMA/OECD https://thelogicalindian.com/news/how-gold-obsessed-is-india-know-the-facts-about-private-gold-why-govt-need-it/ World Gold Council 2015 report http://in.reuters.com/article/india-gold-deposit-bank-interest-idINKBN0O41JP20150519

3. Integrating the Banking system with India’s gold related initiatives Themes Key activities Sourcing gold bullion by Banks Authorize Banks to source domestically refined gold / silver bullion from domestic refineries having acceptable quality standards Permit RBI authorized banks operating GMS to deliver GMS gold to domestic accredited refineries for manufacture of Banks’ customized gold minted coins The higher operating margin from coin sales will enable Banks incentivize GMS gold across all schemes Banks may negate resultant exposure by buying physical gold from refineries back-to-back with coin sales Enabling Banks push the Gold Monetization Scheme (GMS) Enable Banks buy-back minted gold coins Permit banks to “buy back” their minted coins, in collaboration with domestic accredited refineries; this will also increase the pool of gold being monetized https://thelogicalindian.com/news/how-gold-obsessed-is-india-know-the-facts-about-private-gold-why-govt-need-it/ World Gold Council 2015 report http://in.reuters.com/article/india-gold-deposit-bank-interest-idINKBN0O41JP20150519

Treat Dore remittances on par with remittance norms for raw material 4. Support Make in India by clarifying the distinction between Gold Bullion (a finished product) and Gold Dore (a raw material) Themes Key activities Import of gold Dore is governed by the EXIM policy notified by DGFT and RBI does not regulate it RBI Master Direction No. 17/2015-16 dated 1st January 2016, updated as on March 31, 2016 (RBI/FED/2015- 16/12) deals with import of goods and services into India. In terms of above Master Circular, Banks may permit settlement of import dues delayed due to financial difficulties, etc. Para C.11.2 of the Master Direction addresses import of gold jewellery and limits the trade credit for import of gold in any form, including jewellery made of gold/precious metals…. to not exceed ninety days from date of shipment. Gold Dore is an industrial raw material, which has to be processed and refined into gold, hence a remittance treatment for raw material must also apply for gold Dore; the ability of gold refineries to settle the dues with the overseas supplier is inextricably linked with their ability to sell the refined output in the market Treat Dore remittances on par with remittance norms for raw material https://thelogicalindian.com/news/how-gold-obsessed-is-india-know-the-facts-about-private-gold-why-govt-need-it/ World Gold Council 2015 report http://in.reuters.com/article/india-gold-deposit-bank-interest-idINKBN0O41JP20150519

Permitting export of Gold/Silver Mitigating unwanted transactions 5. Enable export of global best in class Make in India product (London Good Delivery bars) and support balance of payments Themes Key activities Permitting export of Gold/Silver Permit export of London Good Delivery Gold bars produced by domestic LBMA Good Delivery refiners to Bullion banks overseas This will bring foreign exchange into India and mitigate the CAD Mitigating unwanted transactions To avoid any abuse and assure a healthy two-way trade in gold, the duty refund may be given in the form of a duty credit, to be used only for any subsequent import of gold Dore and for no other purpose Suggested process Export of London Good Delivery gold bars should be at London AM Fix ruling on the date of export, with a duty refund equivalent to the import duty ruling on the date of each export. https://thelogicalindian.com/news/how-gold-obsessed-is-india-know-the-facts-about-private-gold-why-govt-need-it/ World Gold Council 2015 report http://in.reuters.com/article/india-gold-deposit-bank-interest-idINKBN0O41JP20150519

6. Applying global norm for settling gold/silver content in gold Dore Themes Key activities Current constraints faced by domestic refineries Transactions with mining companies are in terms of ounces of the fine metal content in the Dore Letters of credit can only be established in USD, i.e. a financial currency An intermediary needs to interface between a metal ounce settlement with the mining company and a USD settlement via a letter of credit established by Indian refinery, needlessly increasing transaction costs Maintaining unallocated Loco London metal accounts Globally Banks transact precious metal (gold/silver) content through Unallocated Loco London Precious Metal Account they maintain with international bullion banks Permit domestic accredited refineries to maintain Gold & Silver Unallocated Precious Metal Accounts with an overseas bullion bank for their precious metal transactions Ensuring stringent regulations Every metal transaction must be backed by a corresponding physical mirror transaction. No speculative transaction to be permitted Authorized Dealer (Bank) of the refinery submits periodic returns to RBI.

Going forward 3.

What does this mean for stakeholders What we should aim for Themes What does this mean for stakeholders 1 GST rates from medium to high Physical gold discouraged, investment in dematerialized form Encouraging local circulations, greater role for financial institutions Low duty on dore 2 Increased share of dore in imports, promoting make in India Greater role for refiners Increased emphasis on responsible gold 3 Enhanced reputation and reduction in unofficial transations Greater role for good delivery players on the value chain Increased 2 way trade 4 Enabling exports and creating a productive use of Indias gold stock Greater role for financial institutions Black money tackled via stringent KYC. Digital gold products such as GMS and GAP 5 Transparency across the value chain Quality becomes the differentiator

What would this mean for the economy Reduced demand for imports Increased refining activity within the country as domestic Gold is brought into circulation Gradual decrease in demand for physical gold/jewellery and an increase in investment demand Opportunity to reshape the Gold Industry and introduce products that will appeal to the younger population

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