Tag Archives: Commodity

Mar 18

Is import duty hike curb the gold demand?

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On 21st January 2013 government raised the import duty on gold by 2 percent to 6 percent; this is the second hike in one year. Before this, in March 2012 government lifted import duty to 4%. On the very next day government increased the import duty on gold dore bars to 5% from 2%. Government’s action to pull up the import duty on dore will bridge the gap on import duties on bullion bars and dore, which had become an attractive import since April 2012, when the government doubled the tax on refined gold purchases from abroad to 4%.

What forced Government to take this action?

India is the world’s biggest importer of gold. For the past few years India imports gold around 800-1000 tonnes a year. According to the World Gold Council imports of gold by India stands at 223.1 tonnes out of 742.8 tonnes of the total world demand in the third quarter of this year, which is 9 per cent higher compared to same quarter of the previous year.

The decision of import duty hike is primarily aimed at trimming rising Current Account Deficit by discouraging investor from buying gold. Presently rising imports of gold have worried the government, which is battling a record high current account deficit. India imported $56.5 billion worth of gold in 2011-12, and by the end of December 2012, the country had already made purchases worth $38 billion. Gold has the biggest contribution on India’s current account deficit after crude oil. India’s current account deficit reached an all-time high of 5.4 per cent of gross domestic product in the July-September quarter. Due to the broadening current account deficit, mainly driven by large scale gold imports, the government was forced to raise the import duty on gold.

Finance minister Mr. P. Chidambaram had indicated that government will take measures to bring down the imports of gold after the release of unfavorable economic data on 2nd January anticipation of import duty hike led to a 15% increase in January import of gold to 75 tonnes as compared to the 65 tonnes of January 2012.

Gold: A Sound Investment

Gold is the most attractive asset and a savings instrument which gives nearly 30 per cent returns annually. Investor flock to gold as the metal is an excellent hedge against inflation. In 2011-12, WPI was up 8.9 per cent, whereas gold prices were up 33.5 per cent. The influential factor that reduces the impact of import duty hike is India’s penchant towards gold for weddings and other religious ceremonies. India’s gold imports have been relatively price-inelastic. Despite gold prices in dollar terms increasing by 26.4 per cent and 27.2 per cent in 2010-11 and 2011-12, the volume of gold imports increased by 12 per cent and 9.2 per cent, respectively.

Government prior steps became worthless

Historically, currencies were backed by gold. Government of India introduced gold control order in 1963 and gold control act in 1968 to control the gold related activities but these steps failed to yield the desired result. In 1963 after the border dispute with china, drains foreign exchange of India. To conserve precious foreign exchange Morarji Desai, finance minister came out with gold control order 1963 on which the production of gold jewellery above 14 carat fineness was banned, but this step didn’t work as per the expectation. In 1968 he imposed gold control act which prohibited citizens from owning gold in the form of bars and coins. All existing holding of gold coins and bars had to be converted to jewellery and declared to the authorities. Goldsmiths were not allowed to own more than 100g of gold. Licensed dealers were supposed to own between 400gm to 2kg of gold, depending upon the number of artisans employed by them. They were banned from trading with each other. However gold control act also failed to curb the import of gold. The response of the act was completely unexpected; it encourages the smuggling of gold. Indians denied the step of Morarji Desai and follow the unofficial and illegal path.

In early 90’s gold control act was abolished when Government of India had to transfer 40 tonnes of gold to London and swap for foreign exchange to tide over the country’s balance of payment crisis. After abolition of act government placed import duty on gold of Rs 250 on per 10 gm.

Impact of import duty hike on gold

Recent step of import duty hike, industry experts believe that it will only have a moderate effect on gold demand. As on date of announcement gold price went up by 1% and touched Rs.30847 mark at MCX on February contract, but the continuous appreciation of Indian rupee against dollar mitigated the rise to some extent. On 2nd January, February gold contract was trading at around Rs.31000 and USDINR January contract was trading at 54.5675. On the expiry day of USDINR i.e. January 29, the USDINR contract closed at 53.6975 and as can be seen that due to the appreciation of the INR Gold also went down to Rs.30234 The depreciation of USD against INR is mainly attributed to economic slowdown in US.

 

Chart showing daily return on GOLD and USDINR

India’s government also took series of steps last year to reduce gold imports, including an earlier increase in the import duty and banning banks from lending money to customers to buy gold. In beginning years of 21st century when the import duty on gold was 1%, import of gold was around 800 tonnes. In the year 2011 import duty was increased to 2%, and then country imported around 1,000 tonnes. In 2012, government raised duty to 4% and still country imported another 800 tonnes of gold.

Final thoughts

To summarize, it is very difficult to say that hike on import duty on gold will curb the demand as gold has always been regarded as best investment to hedge against inflation. By raising duty, it will only encourage illegal channels to replace official import channels as gold is required from birth till death in Indian tradition. Import duty hike on bullion has widened the gap between the Indian and international prices and this will force people to choose the smuggling route and illegally bring yellow metal in the country. Smuggling of gold has been increase by 8 times in current fiscal year compared to previous year and becomes headache for the Directorate of Revenue Intelligence (DRI). During current fiscal year DRI has seized Rs. 60.17 crore of smuggled gold, but India imports illegally much more to this. According to DRI officials they detect about 1 case in every 10 cases.

To discourage investment in physical gold government should introduce alternative financial instrument which provide an inflation hedge, attractive gold related schemes and gold backed financial products.

Jan 29

Counterview-People’s Love for Gold

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On 27th November 2012, an article was published in the business daily Mint of HT Media Ltd. comparing people of India and United States of America on the basis of their love for the yellow metal. Here is the link to the article, which is also available on the website of the newspaper http://www.livemint.com.

The article compared the legislation of the two nations which controlled the private holding of gold by their respective citizens. The article pin-pointedly describes, how both the countries, at different points of time, enacted the legislation and how the citizens of each country dealt with the similar situations. It has been very well and factually compared that U.S. legislation worked effectively in-line with the motive, whereas, Indian Act didn’t proved to be that much fruitful.

The Charismatic Gold

There is no doubt about continuing obsession of Indian people for yellow metal and because of that only, the country has remained the largest consumer as well as the largest importer of the gold for many years. But this obsession has made the country net importer in the global trade domain and has also led towards widening current account deficit (CAD) at alarming levels. And this is the only concern that has compelled the writer of the article to compare the characters of the citizens of the two countries.

In our view, where result of this character examination of the citizens on the particular subject-matter is very true; it presents only the half-truth. And in order to understand the reasons behind this obsession and provide an effective solution to keep country’s interest supreme, we are required to explore and take this matter one step ahead.

Solution lies in the problem itself…

As per our opinion, here are the few points that illustrate this obsession as well as indicate the solution to the problem:

  1. In the ancient global trade regime, gold has been widely accepted as standard and medium of monetary exchange. Not only Indian but many other civilizations also have accepted the gold’s standard monetary value.
  2.  This standard of gold has not even been diluted, forget about being challenged, in the Fiat currency regime. Let’s have a tour to the historical monetary systems:

    While using a varied range of commodities for monetary exchange world accepted silver and gold as standard for different coins and bank notes during the year 1750-1870. When this era experienced crisis for silver currency and bank notes world moved towards gold exchange standard in 1870 which lasted till 1914, outbreak of the World War I.

    During the two World Wars for a brief stint, world moved to floating currency exchange regime which was followed by the prolonged great depression and ended with the Bretton Woods Agreement in 1944. With this agreement world was again back to the gold standard. In 1971 world entered in the era of fiat currency and abandoned the gold standard.

    Now after almost 30 years we are again witnessing the sovereign credit defaults, the illogical money printing spree and amassing gold deposits by central banks.

    Here comes the Big Q??? Are we heading towards gold backed standards again?

    One can always debate the issue, but cannot ignore the gold. Can you?

  3. It has been time and again proven that among all asset classes only the yellow metal effectively provide hedge against the inflation, which is the mother of all evil.Not only hedging effectively but gold has also surpassed any other asset class by providing more than 600% return in the last 10 years time-span.
  4. Last but not the least, where other countries have successfully provided the alternatives to the physical gold holding in form of ETFs, Gold Funds, Gold Index and other market linked alternatives, in our country these alternatives are in their nascent stage.

Neither the Government nor the regulators have made any sincere attempt to educate the investors about these alternatives and their advantages. Rather they have indulged in draconian measures like banning the imports or hiking the duties.

How can you depose people from owning, what they consider is the respite to them in these turbulent times, when your central bank itself is continuously cornering on.

Cure the disease, not the symptoms

Considering these reasons it is clear that governance is the problem which has landed the country in this mess; not the citizens of India. They are only trying to opt for the best available recourse through which the value of their holdings can remain intact.

Howsoever, one may agree with the problem, but cannot agree with the last line of the article:
“Perhaps India is where it is today because Indians back-stabbed Desai’s Gold Control Act, 1968.” Rather we think, it is the people those are back-stabbed by the regulator and the governments when they turned blind-eye towards the crooks when they snatched the hard-earned savings of the people through ponzi schemes.

Nov 16

Commodity Derivatives in India

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Background

The Commodity Futures Market in India dates back to more than a century. The first organized futures market was established in 1875, under the name and style of ‘Bombay Cotton Trade Association’ to trade in cotton contracts, just 10 years after the establishment of Chicago Board of Trade (CBOT) in USA and thus became the 2nd oldest commodity exchange in the world. Subsequently, many regional exchanges like Gujarat Vyapar Mandali (1900) for oilseeds, Chamber of Commerce at Hapur (1913) and East India Jute Association Ltd. (1927) for raw jute etc. came into existence. By the 1930s, there were more than 300 commodity exchanges in the country dealing in commodities like turmeric, sugar, gur, pepper, cotton, oilseeds etc. This was followed by institutions for futures trading in oilseeds, food grains, etc.

The futures market in India underwent rapid growth between the period of First and Second World Wars. As a result, before the outbreak of the Second World War, a large number of commodity exchanges trading futures contracts in several commodities like cotton, groundnut, groundnut oil, raw jute, jute goods, castor seed, wheat, rice, sugar, precious metals like gold and silver were flourishing throughout the country. Trading was conducted through both options and futures instruments. However, there was no market regulator and hence there was no uniformity in trading practices. Further, there was no structured clearing and settlement system.

In view of the delicate supply situation of major commodities in the backdrop of war efforts mobilization, futures trading came to be prohibited during the Second World War under the Defence of India Act. After the dawn of independence, the futures markets were put under the Central List of subjects under the Constitution of India. In its wake, the Forward Contracts (Regulation) Act, 1952 (FCR Act, 1952) was passed to regulate this market with Forward Markets Commission (FMC) being set up in 1953 at Mumbai as the regulator. However options, which were then perceived to be risky instruments of trading, were totally banned under the Act itself. Futures trading started to gain momentum in many commodities. However, in the mid-1960s, the Government imposed a ban on the futures trading of most of the commodities on the assumption that this led to inflationary conditions.

Reopening of the Forward Markets

The National Agricultural Policy announced in July 2000 recognized the positive role of forward and futures market in price discovery and price risk management. In pursuance thereof, Government of India, by a notification dated 1.4.2003, permitted additional 54 commodities for futures trading and 3 national electronic commodity exchanges came into operation in the same year. With the issue of this notification, prohibition on futures trading has been completely withdrawn.

Since then several changes have taken place in the Commodity Futures Market. There are now 21 commodity Exchanges in the country including five National Multi-Commodity Exchanges, located at Mumbai (3), Ahmedabad (1) and New Delhi (1). All these five national exchanges are state-of-the-art, demutualized & corporatized trading platforms with professional management from the beginning with facilities for on-line trading across the country. At present, 110 commodities have been notified for trading and more than 40 commodities are actively traded.

Suitability of a commodity for futures trading

Futures trading can be organized in those commodities/markets which display some special features. The concerned commodity should satisfy certain criteria as listed below:

  1. The commodity should be homogenous in nature, i.e., the concerned commodity should be capable of being classified into well identifiable varieties and the price of each variety should have some parity with the price of the other varieties;
  2. The commodity must be capable of being standardized into identifiable grades;
  3. Supply and demand for the commodity should be large and there should be a large number of suppliers as well as consumers;
  4. The commodity should flow naturally to the market without restraints either of government or of private agencies;
  5. There should be some degree of uncertainty either regarding the supply or the consumption or regarding both supply and consumption,
  6. The commodity should be capable of storage over a reasonable period of time.

Economic functions of the futures markets

In a free market economy, futures trading perform two important economic functions, viz. price discovery and price risk management. Such trading in commodities is useful to all sectors of the economy. The forward prices give advance signals of an imbalance between demand and supply. This helps the government and the private sector with exposure to commodities and price volatility to make plans and arrangements in a shortage situation for timely imports, instead of having to rush in for such imports in a crisis-like situation when the prices are already high. This ensures availability of adequate supplies and averts spurt in prices. Similarly, in a situation of a bumper crop, the early price signals emitted by the futures market help the importers to defer or stagger their imports and exporters to plan exports, which protect the producers against un-remunerative prices. At the same time, it enables the importers to hedge their position against commitments made for import and exporters to hedge their export commitments. As a result, the export competitiveness of the country improves.

Participants in the Commodity Futures Markets

There are three broad categories of participants in the futures markets, namely, hedgers, speculators and arbitrageurs.

Hedgers are those who have an underlying interest in the specific delivery or ready delivery contracts and are using futures market to insure themselves against adverse price fluctuations. Examples could be stockists, exporters, producers, etc. They require some people who are prepared to accept the counter-party position.

Speculators are those who may not have an interest in the ready contracts, i.e., the underlying commodity, etc. but see an opportunity of price movement favourable to them. They are prepared to assume the risk which the hedgers are trying to transfer in the futures market. They provide depth and liquidity to the market. While some hedgers from demand and supply side may find matching transactions, they by themselves cannot provide sufficient liquidity and depth to the market. Hence, the speculators who are essentially expert market analysts take on the risk of the hedgers for future profits and thereby provide a useful economic function and are an integral part of the futures market. It would not be wrong to say that in the absence of speculators, the market will not be liquid and may at times collapse.

Arbitrageurs are those who make simultaneous sale and purchase in two markets so as to take benefit of price imperfections. In the process they help, remove the price imperfections in different markets, For example, the arbitrageurs help in bringing the prices of contracts of different months in a commodity in alignment.