With the large duty on Gold imports, and very large gold requirements in an inflationary economy, the issue of “how can we reduce Gold imports” has driven RBI to an interesting solution.
Economic Times reports that RBI will swap Gold it owns in India for Gold deliverable in London. The official reason is that the Gold is sought to be replaced with that of a purer variety.
Here's how the proposed swap scheme between RBI and banks would work: RBI will give delivery of gold from its Nagpur vault to banks in India while taking delivery of gold from banks in London.
But the gold that RBI would give to banks in India could be of a slightly inferior quality compared with the 'London deliverable' purer gold that it would receive from banks in London. The banks will deposit the gold in London in RBI's account with Bank of England.
But what does this swap really do?
Ease Gold Supply in India Without Hitting CAD
Since RBI will sell gold in India to Banks who can sell onward to jewellers, the supply issues in India will ease. Currently, Banks import Gold for jewellers, who have to pay upfront, and then they can only reimport another batch if 20% of the last batch has been exported. And then, there’s a 10% duty on imported gold.
If the RBI were to swap, for instance, 10% of it’s gold, that’s an additional 50 tons of gold (1/10th of its holding) that would be 50 tons less that was imported.
In context, that’s about a month’s requirement of imports.
Why will it not impact the CAD?
Effectively, Swaps Dollars for Rupees, Contracts Money Supply
When RBI buys gold in India it will receive rupees. The purchase in London will be paid for in Dollars. Those dollars are already owned by the RBI as forex reserves. So effectively, the RBI will sell dollars it owns and the rupees it receives will go out of circulation.
In that context, the quantum of gold sold will impact money supply, a little bit. India owns $21 billion of gold, worth about Rs. 120,000 cr. (1.2 trillion), so a 10% contraction is about Rs. 12,000 cr.
A reduction of money supply by 12,000 cr. is not a big deal, and can be replenished easily; the RBI routinely buys dollars by printing rupees anyhow, and it can do an OMO auction to buy bonds.
Capital Mind View
This is good for Gold companies, but only if the quantum is known. If the RBI does this for tiny amounts, it’s insignificant. If it swaps more than 50 tons, it will help ease supply pressure in the next 6 months.
In any case we expect a graded withdrawal of limits on gold imports and the import duty over the next year. In fact, we expect an announcement of the process in the budget, followed by RBI in it’s next Policy statement in August.
If you ask us about how it impacts markets, then our answer in the current situation is: everything will impact the market positively nowadays. There is no news that can even be considered remotely negative. So, that.