(Updates with exchange-traded products in 9th paragraph.)
Dec. 3 (Bloomberg) -- Korea Exchange Inc. will begin physical gold trading on March 24 as Park Geun Hye’s government seeks to wring tax revenue out of a market that’s dominated by illegal transactions.
The exchange will use 1 gram units of bullion of 99.99 percent purity to spur liquidity and delivery will be in 1 kilogram bars, the bourse said in a statement today. Trading will start on a test basis for two weeks from Feb. 10 before full operations, it said.
South Koreans hold seven times as much gold as the 104.4 metric tons in their central bank’s vaults and the majority of trading is on the black market to evade import duty and value- added tax, according to government estimates. Park, who marks the one-year anniversary of her election as president this month, scaled back welfare pledges in September as her administration forecast the first drop in revenue in four years.
“It’s a positive move to combat the underground market,” said Johnston Bae, a director at Eugene Investment & Futures Co. in Seoul. “The timing is good as gold prices fell this year, offering cheaper entry levels for physical buyers.”
Gold climbed from a near five-month low today, following the biggest one-day drop since October yesterday, as investors assessed whether the U.S. economy was strong enough to warrant a reduction in monetary stimulus.
Bullion, which lost 27 percent this year and is on course for its first annual drop since 2000, rose 0.3 percent to $1,223.45 an ounce at 7:04 p.m. Seoul time.
Asia’s fourth-largest economy, which already has gold futures trading on Korea Exchange, has been mulling plans for a physical bullion market since at least 2010.
It’s forging ahead even as mining companies make at least $26 billion of writedowns this year and billionaire John Paulson stops personally investing more in his gold fund.
Holdings in gold-backed exchange-traded products fell to 1,839.8 tons on Dec. 2, the lowest since March 2010, data compiled by Bloomberg show. Still, demand in Asia surged this year, led by consumer buying in China and India, where limited investment choices and tradition bolster the metal’s appeal.
In South Korea, small local refiners that typically employ a handful of people and operate below the level of corporate smelters may recycle as much as 4.5 trillion won ($4.2 billion) of gold scrap and jewelry into bars each year, the Financial Services Commission said in July.
Illegal trading to avoid tax accounts for as much as 3.3 trillion won of that total, depriving the government of 300 billion in tax revenue, it estimated.
The 3 percent import duty on gold may be waived for bullion traded on the new market, Korea Exchange said in a presentation in November. Investors may still be required to pay 10 percent value-added tax when they take physical delivery of gold purchased on the exchange.
“There is some skepticism because people may prefer to keep using underground transactions unless more incentives are offered to trade on the bourse,” said Lee Won Jae, an analyst at SK Securities Co. in Seoul.
As much as 110 tons of gold are traded in South Korea every year, with illegal transactions to avoid tax accounting for as much as 70 tons of this figure, the commission estimates. Individuals hold as much as 720 tons, Korea Exchange said in July, citing a survey by the Wolgok Jewelry Research Center and Gallup Korea.
The Korea Customs Service made 19 gold seizures in the 11 months through November, collecting 344 kilograms of the metal, said Jo Bong Gil, the deputy director of the investigation and planning division. He wasn’t able to estimate how much bullion comes through undetected.
“If the government offers tax benefits, it will help physical traders and retailers keep away from the black market and eventually raise the government’s tax income,” said Ohn Hyun Sung, a director of the Wolgok Jewelry.
Physical gold trading on the new market will be from 9 a.m. to 3 p.m. local time, Korea Exchange said.
--With assistance from Eunkyung Seo and Sam Kim in Seoul. Editors: Brett Miller, Alexander Kwiatkowski