India's Gold Supply

India buys one ounce of gold in every five sold worldwide each year. How does it get there...?

INDIA has the largest gold market in the world, but the domestic production of gold has always remained negligible, reports Commodity Online, meaning that its gold supply must come from foreign sources.

The main domestic producers of gold in India are Hutti Gold Mines and Bharat Gold Mines Limited, which annually produce about two tons. So how does India get its gold supply, and what is the process involved?

Well, from the late 1940s until 1991, practically all gold supplied to India came through illegal smuggling!

India had been importing substantial amounts of gold for nearly two centuries. Between 1831 and 1931, annual imports of gold to India averaged 37 tonnes. In the 1930s – during the Great Depression – this inflow rose to an average of around 140 tonnes per year. But this trend was reversed in the following decade, including WWII, when net imports of gold fell to 31 tonnes per annum.

From then, and despite the imposition of a ban on gold imports in 1947, net imports – practically all of it illegally smuggled – increased progressively to 80-90 tonnes per annum during the 1950s and close to 150 tonnes per year during the '60s and early '70s.

After the sharp decline in the 1970s gold imports then surged again in the 1980s. Following the lifting of the ban and the permitting of gold imports in 1992, the rate of imports increased sharply again.

There was a big spurt in gold consumption in India following both the economic liberalization and the relaxation on gold imports in 1992. Gold consumption remained around 400-425 tonnes per annum over the next couple of years. Before resuming the rising trend, estimated consumption was more than twice the level recorded in 1990 and nearly 70% higher than in 1992.

Since liberalization, the share of smuggled gold has progressively declined both in absolute terms (from an estimated 290 tonnes in 1994 to 94 tonnes in 1998), and even more so in relation to total consumption (from over 70% in 1990 to less than an 8% in 1998). The decline in smuggled gold was the direct result of progressive realization of gold imports (subject to payment of 15% duty) and a considerable narrowing in the margin between international and domestic Gold Prices. This margin in 1998 was close to the import duty on gold. However the volume of smuggling – at 90 to 100 tonnes per year – remains quite large in India. A smuggler who successfully escapes the customs net still stands to make substantial profits.

A major step in the development of India's gold markets was the authorization in July 1997 by the Reserve Bank of India for commercial banks to import gold for sale or loan to jewelers and exporters. Initially, seven banks were selected for this purpose on the basis of certain specified criteria like minimum capital adequacy, profitability, risk management expertise, previous experience in this area, and so on. At present, 14 banks and institutions are active in the import of gold. The quantum of gold imported through these banks has been in the range of 500 tonnes per year.

Gold Bullion enters India through a number of different routes. The gold trade routes are complex but can be classified into two broad categories: Direct flow (official) and indirect flow (unofficial flows).

Indirect flows (unofficial) still occur, and they tend to take place from the foreign entry ports of Singapore, Sri Lanka and Dubai in the first instance.

Direct flows include shipments from the refining centers of Europe, South Africa and Australia. Imports through direct flows are done in three ways:

1. Special import licenses;
2. From non-resident Indians;
3. Authorized banks and institutions.

Imports of gold by Special Import License (SIL) have been negligible since gold imports through banks was permitted. The liberalized gold policy has brought most of the unofficial trade into the official sector.

The coincident elimination of large unofficial markets in foreign exchange has also improved the effectiveness of India's policy on gold imports. It may also be noted that the Indian consumer of gold has been spared huge transaction costs amounting to thousands of crores of rupees on account of the existence of the unofficial sector in the past.

And what are the major factors influencing the gold supply in India?

• Supply of gold follows India's Gold Bullion Demand;
• The difference between domestic Indian-Rupee and the international Gold Price also acts as an inducement for smuggling with the objective of earning large Rupee income;
• Smuggling is operationally feasible only if the foreign currency needed to fund it can be obtained outside the legal forex market.

For India's gold smugglers, this extra-legal foreign exchange can be obtained from the informal network of Middle Eastern and Asian dealers making up the "Hawala Market". So the relative hawala premium on foreign exchange of Indian Rupees should also be considered another factor influencing the supply of gold to Indian buyers.