Aug 17, 2017

Round Tripping and the Ban on 23 & 24 Carat Gold Exports

A few days ago (14th Aug), the Directorate General of Foreign Trade (DGFT), Ministry of Commerce, GOI, banned the export of gold jewellery, coins and medallions with purity above 22 carats. This means that Indian exporters can now only export gold products of purity of 22 carats or below.

Why did the Government do this? 

While the order did not give any official reason, most believe it is to help curb what is called “Round tripping”. In the context of gold, “Round tripping” refers to the practice where traders import gold, usually at low import duties/taxes and then subsequently export this gold without any value-addition or with minimal value addition (change packaging etc.). This is done mainly to avail of benefits such as cheap financing from banks by inflating trading volumes, higher import entitlements (this happens when import entitlements are linked to export volumes) or to simply profit from differences in tax rates/ interest rates/ exchange rates. 

Why is Round tripping undesirable? 

Round tripping is undesirable for a variety of reasons. First, it is against the law. Second, while traders indulging in this practice end up profiting and garnering bank finance at favourable rates, genuine traders suffer as these benefits are not available to them to the same extent. Three, Round tripping artificially inflates gold import and export figures for the nation in question. Since gold imports (India is one of the largest importers of gold in the world) require payment in dollars, high import volumes put a drain on our Current Account Balance and contribute to the depreciation of the Rupee. This is why in times when the Rupee has depreciated strongly due to deterioration in our Current Account Balance (when imports > exports, we need more dollars than foreigners need rupees, so the rupee depreciates vs. the dollar), the government has usually taken steps to discourage the import of gold and curb Round tripping. 

How much are Rounding tripping volumes for India?

While there are no official estimates, industry sources estimate gold Round tripping volumes at ~150-200 tonnes/year. For context, India imports roughly 800-900 tonnes of gold annually. 

Why is it hard for the government to prevent Round tripping?

It is hard for the government to prevent Round tripping because while it wants to clamp down on this practice, it doesn’t want to penalize genuine traders in the process. For example, in early 2015 the government tightened value addition norms in order to prevent Round tripping. As part of this exercise, for plain gold jewellery articles, value addition norms were raised from the earlier 3% to 4%. This meant that traders would have to add at least 4% value to imported gold in order to export it in the form of plain gold jewellery. 

Such a measure adds to the cost of exporting. Thus in theory, you cannot keep exporting gold without any value addition and keep importing it back multiple times if each time you export this gold, it is priced at least 4% higher. This will make Round tripping unviable. 

But at the same time when the government does something like this, it wants to ensure that the value addition norms aren’t so high that they discourage genuine exporters of gold jewellery and make their products uncompetitive in the world market. 

Will the current order Banning 23 and 24 Carat Exports curb Round tripping? 

This is a good question. Per Surendra Mehta, National Secretary, India Bullion and Jewellers Association (IBJA), the leading industry body representing gold jewellers and dealers in India, there isn’t much scope for value addition in 23 and 24 carat purity gold when it is converted to gold jewellery and medallions (link to the article in Business Standard where he is quoted). 

Experts tend to agree that it is difficult to make high quality jewellery out of 23 and 24 carat gold. 

Hence, the government’s logic is that those claiming to ship gold jewellery and medallions of 23 and 24 carat purity are likely indulging in Round tripping. This is why the government believes that banning these shipments will plug at least one channel of Round tripping.

The logical next question is how much gold jewellery / medallions of 23 and 24 carat purity are exported out of India? The same Business Standard article (link here) that I referenced above states that per an industry estimate, India exports ~170 tonnes of jewellery and medallions made of/ studded with gold. Ornaments made of 24-carat gold apparently form ~15% of this volume or ~25 tonnes. 

If we assume that all of these 25 tonnes of export comprised Round tripped gold (extreme assumption), then it follows that of the 150-200 tonnes per year of Round tripping, 25/175 or ~15% has been plugged.

Remember, there are a lot of assumptions and rough estimates here. This is just a back-of-the-envelope exercise. 

What about the recent surge in Gold Imports from South Korea?

Read my post The Recent Surge in Gold Imports from South Korea: the History, the ‘Why’ and the ‘How’ explained in detail for this discussion.

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