Gold price rise poses a systemic long-term risk of jewellers' default

Topics Gold  | Gold Prices

Soaring gold prices may have raised value of the existing inventory of the bullion jewellery, but pose a systemic risk for medium and large size jewellers who avail gold loan from lenders and now required to pay the mark-to-market margin. Since the fresh sale of jewellery is quite low, they are forced to use the money collected through investors’ monthly deposit scheme for paying margin. 

Jewellers practising ethical business are needed to buy gold as underlying on the day they receive a monthly share of jewellery deposit. These deposits are usually for 11 months and on maturity, depositors get gold jewellery worth deposit amount with some benefits. 

Jewellers take gold metal loans from banks, which means they receive gold bars as loan and on maturity they have to return physical gold. The gold loan is used for converting it in jewellery and is usually of 6 months so making jewellery and selling it is completed and from the sale price, jewellers buy gold bars and return to lenders. In a stable price market, this is the best route as interest rates for gold metal loans are around 4 per cent. Size of the gold metal loan market is estimated at around 120-130 tonnes per annum. 

The sharp increase in gold prices over the last three months has prompted lenders to call for margin money from gold loan borrowers who are mostly medium and large sized jewellers. This is usual practice but at high price as demand has fallen significantly and there is a risk for banks in recovering metal loans. 

As the retail sales of jewellery have disappeared at the current price and banks are unwilling to extend additional credit, jewellers don’t have any option but to divert investors’ (scheme) money to pay lenders’ margin. 

When the current schemes mature say six-nine months down the line, jewellers might not have adequate underlying gold or ornaments to service investors’ call for redemption. Since only medium and large jewellers are entitled to avail the gold loan, the fear of default looms with leading jewellers across the country. Small jewellers anyway don’t get a gold loan from lenders even against 100-120 per cent collateral. Still, the apprehension of default is set to spill over to small jewellery units as well. 

“Jewellers are using investors’ money collected through various monthly deposit schemes to pay the mark-to-market margin with every increase in price. Ideally, jewellers should buy gold as underlying against the money deposited by investors. Since gold prices are rising unabated, the fund diversion by jewellers pose a big systemic risk when the existing deposit schemes come for redemption,” said Surendra Mehta, National Secretary, India Bullion and Jewellers Association (IBJA), a premier industry body of bullion dealers and jewellery retailers. 

Many jewellers run monthly deposit schemes like a systematic investment plan (SIP) for the period beginning nine months to one year and above to ensure customers purchase of some volume of gold on maturity. Jewellers also offer a discount on making charges and buying of additional value over and above the deposit money to lure customers. 

“Unfortunately, the quantum of deposit money has been declining drastically since gold prices started upward march in June. Customers are unwilling to renew the scheme at the current gold price. Hence, jewellers are facing a huge liquidity crisis,” said N Anantha Padmanaban, managing director, NAC Jewellers, a Chennai-based jewellery manufacturer and retailer and chairman of All India Gems & Jewellery Domestic Council (GJC). 

Meanwhile, money collected through schemes contributes nearly two-third of jewellers’ liquidity requirement. Hence, declining renewal of existing schemes causes a big worry for jewellers. 

Gold prices have jumped by 21.2 per cent in the last three months to trade currently at Rs 38560 per 10 grams in the benchmark Zaveri Bazaar here. 

Meanwhile, the value of ornaments in stocks with jewellers has gone up in proportion to the gold price rise. But, the increase in stock value will benefit jewellers only with the sale in ornaments. 

Also, the incidence of smuggling has ramped up with an increase in gold import duty. With the benefit of 15.5 per cent, gold is available at 4 per cent discount in the grey market which hurts legitimate business houses hard. 

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