Indian Bullion: A discussion of "ex-duty premiums"
November 30, 2004, 04:00 AM
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For centuries, India has been a massive importer of both gold and silver. For the Hindu majority in particular, gold jewelry and silver ornaments have deep appeal rooted in culture and tradition. Local mine supplies are limited.

India is by far the biggest importer in the world. One of the largest participants in the business has estimated the country might import 880 tonnes this year. This would be a third of global mine production.

A popular estimate is that some 15,000 tonnes of gold is in private hands in India. That is some 10% of the total world gold stock. By contrast, Central Banks claim to have a total of just over 31,000 tonnes, but an unknown quantity has been lent ("leased") out. Actual gold holdings of the Central Banks and the Indian public may in fact be quite similar.

Indians are constantly buying and selling gold to one another. Prices for the various grades and sizes popularly traded are collected by merchant associations and reported for many cities by the Indian press, usually on a twice daily basis. These could be thought of as the "small wholesale" or "large retail" prices. It is reasonable to assume that the high public interest, and competitive pressure between the news vendors, keeps them realistic.

For over 30 years, the import of gold into India was illegal, which lead to heavy smuggling. Starting in the mid 1990s more enlightened policies were progressively adopted such that gold (and silver) can now be imported freely on payment of a moderate duty.

What is of interest to outsiders is, are prices in India high enough to pay the costs of importing? Essentially, this means buying the gold in the world market by converting rupees into dollars, shipping it, paying the import duty (currently10.2 Rupees per gram), the sales tax of the local state (supposed to be harmonized at 1%, but there are a few deviants) any other local taxes, and leaving a profit margin.

The two big items are the import duty and the sales tax. I focus on what I call the "ex-duty premium" because it is a clear starting point. So, for instance, in the afternoon of November 30, 2004, in the usually leading import city of Bombay,  0.999 gold was 670.5 rupees per gram. The exchange rate was $1 =R44.6375. This meant that Bombay gold was $467.21 per oz. World gold was $451.85. Import duty came to $7.11 per oz, leaving $8.25 as the "ex-duty" premium. Out of this sales tax would have to be paid, say $4.52, leaving $3.73 for other costs and profit. Gold will be transported immense distances around the world for profits of less than $1 per oz, so it is safe to say that Bombay was a buyer from the world that afternoon.

Modern communications have revolutionized the relationship between the Indian gold trade and the world. Using telephone and the internet, Indian arbitrage dealers/importers trade to the end of the NY day. There have been estimates that laying off their business sometimes accounts for as much as a fifth of Comex volume.

Secondly, and greatly to the irritation of these Indians, it is possible, with some effort, to identify quite precisely gold and exchange rates at the key times of the day and perform these calculations. This would have been impossible only a very few years ago. So it possible to settle quantitatively the question of whether India is or is not an importer at any point.

Indian demand is price sensitive (in rupees). High premiums have been a fairly good indicator of lows in the world gold price. Sometimes, world gold rises high enough that imports are not possible. Very rarely, world prices get so high that the gap between domestic Indian and world prices is not enough to cover the import duty, which creates a negative "ex duty premium". I have never seen Indian prices anywhere near being actually below world prices. Exports sourced in India have therefore never been practical, although it is said these did occur in early 1981.