Why WGC's India gold policy won't make much impact on import "problem"

For all the laudable recommendations (yes, Indians using their own gold to fund their own gold jewellery industry is OK) in the WGC & FICCI's Why India needs a gold policy, I think it fails to articulate a compelling case for the only thing that matters to the Indian Government - reducing gold imports (ie currency leaving the country).

 

Stating it simply, imports will only be reduced by the amount of gold tied up in manufacturing inventories, thereafter Indian's net accumulation urges will have to be satisfied by imports again. The failure of the report to identify the size of manufacturing inventories means the size of import substitution cannot be quantified, denying the report the sort of hard numbers that could attract policy makers' attention.

 

First some facts. The report mentions 22,000 tonnes of gold held in India. Yearly consumer demand is around 800t and WGC's global stock estimates put industrial/manufacturing inventories at around 10% of total gold stock. So that would work out to:

 

Physical Gold held by Indians - 22,000t
Physical Gold held by Manufacturers as work in progress - 2,400t
Yearly demand/addition to stock - 800t

 

Note that Indians are net accumulators of gold (the report notes they spend 8% of their income on jewellery and coins). This means any mobilisation of the 22,000t into bank gold savings schemes does not mean that those people will not buy more gold. All they are doing is changing the way they hold their existing gold savings; they will still want to add to their existing savings (in aggregate). Any mobilised/recycled gold is just sold back to others who don't want a bank gold savings scheme - the total amount of physical gold in the country stays the same, it is just that some are now holding bank gold savings schemes.

 

Lets say the WGC's proposals are so successful that they manage to mobilise 800t a year. So Indian banks don't have to import gold and can instead loan the mobilised gold to manufacturers who then transform it and sell it (their total holdings stay the same). This is how the gold "balance sheet" of India looks after this first year:

 

Indian Physical Gold asset - 22,000t
Indian Gold Savings Schemes asset  - 800t
Bank gold liabilities to Indians - 800t
Bank gold asset (loans) to Manufacturers -  800t
Manufacturer liability (borrowings) to Bank - 800t
Manufacturer Physical Gold asset - 2,400t

 

After three years of this we would have this situation:

 

Indian Physical Gold asset - 22,000t
Indian Gold Savings Schemes asset  - 2,400t
Bank gold liabilities to Indians - 2,400t
Bank gold asset (loans) to Manufacturers -  2,400t
Manufacturer liability (borrowings) to Bank - 2,400t
Manufacturer Physical Gold asset - 2,400t

 

Now what happens in year 4? The banks get another 800t from Indians but they can't loan it to manufacturers as the manufacturers have all the gold financing they need. The manufacturers would be happy to buy the gold from the banks but this would leave the bank with short gold position. If the bank sold the mobilised gold they would have to use the cash to buy replacement gold. As Indians are not net sellers (in aggregate) the banks' only option is to buy gold overseas, but in doing so they send currency out of the country, which is what the Government is trying to prevent.

 

So gold mobilisation is probably only good for a few years worth of gold import substitution and thereafter the Indian Government is back to its "problem". One could add another year or two if the Indian export jewellery industry expanded based on the other recommendations (WGC estimates exports could increase five-fold - but that doesn't translated to work in progress inventory increase of the same size as manufacturers would just increase their inventory turnover). But in the end mobilisation is a temporary solution. Maybe that explains the lack of hard numbers in the report.

 

It is not like the WGC and FICCI could not have worked out the amount of gold tied up in manufacturing - a November 2013 FICCI report in conjunction with AT Kearney (All that glitters is Gold: India Jewellery Review 2013) has a lot of very detailed numbers on the jewellery industry and so working inventory estimates obviously would not be difficult to obtain. My only conclusion is that it was a deliberate strategy of the WGC to avoid putting numbers to the real import substitution potential.

 

Given that many of the recommendations would make it easier to invest in gold both in jewellery and coin/bar, once the mobilisation import substitution ran its course the result would actually be increased Indian gold demand compared to doing nothing and leaving the industry in its current less than optimal state. Maybe I'm too cynical thinking that the WGC knows this and deliberately allows the report to imply to less savvy policy makers that it solves the "gold problem", in which case you certainly don't want to have any hard numbers focusing on real physical gold and currency flows.

 

In my opinion the report does spin the 5006 person (not much in a country that size) survey results quite hard. The survey seems heavily skewed to urban (only 2.44% employed in agriculture), but I don't know what the general population distribution is, and nor does the report indicate if their sample is representative of India in general. The report notes that "more than 49 per cent of respondents said they would be willing to deposit their gold to earn interest while a further 12 per cent said they might do so. Moreover, 72 per cent said they were happy to receive different gold from their initial deposit." OK, so (49 +12) x 72 = only 44% who would actually go with a mobilisation scheme that could recycle gold.

 

The report also noted that "more than a third of respondents would be willing to deposit 25-50 per cent of gold in their possession" (didn't indicate the other respondents % they would deposit). Once you get the 44% then apply a third then apply 25% it would look to me that we are talking about a much smaller amount of the 22,000t that would actually be mobilised, certainly less than the report implies (note that the report says that Turkey only "monetised around 300 tonnes of gold").

 

How much gold Indians would be willing to mobilise is questionable, especially considering the following from the November 2013 FICCI report: "Unlike other financial investment options, many retail transactions in gold can still be done in cash without any documentation. This provides an easy route for investing unaccounted (black) money."

 

Probably the best source of mobilised gold would be the temple trusts, which the earlier FICCI report says "it is estimated by various sources that about 1800-2000 tons of gold is present with the temple trusts in the country" That would probably fund the gold jewellery industry.