The sum of three new gold schemes

The government announced its Sovereign Gold Bond Scheme, which seeks to encourage people to buy gold bonds instead of actual gold.  

The Indian government has come out with >three new gold schemes, the combined purposes of which are to reduce India’s gold imports and bring all the gold lying idle with individuals and households in India into the economy.

These objectives are important. India imported Rs. 2.1 lakh crore worth of gold in the financial year 2014-15, not counting jewellery. So far, Rs 1.12 lakh crore worth of gold has been imported between April and September 2015. The idea is that by reducing these whopping quantities of imports, the government can try to narrow India’s current account deficit and trade deficit (the margin by which India’s imports exceed its exports).

TCA Sharad Raghavan
This is not the first time the government has looked at gold as a means of controlling the current account deficit. It has periodically sought to limit gold imports by increasing the import duty on the yellow metal, but these moves met with limited success.

So, the government has now tried a different route. The first, the >Gold Monetisation Scheme, is exactly as the name suggests — it makes your gold work for you by yielding interest when deposited in a bank. Under the scheme, individuals who deposit their gold (there is no upper limit to how much) in authorised bank, receive interest. It works somewhat like a fixed deposit, with a minimum tenure of one year, but with provision for premature withdrawals should the need arise.

Now, there are three issues with this. The first is cultural: getting Indians to part with their gold, especially when it is in jewellery form, is very difficult. Under the scheme, the depositor has to make clear in the beginning whether he/she wants to redeem it in cash or in gold. Even if it is in gold, it will be in standardised gold bars — the banks will not return the same necklace and earring set you deposited. That is likely to meet with a lot of reluctance.

Sovereign Gold Bonds

» Proposed Sovereign Gold Bonds (SGBs) is part of government’s budget proposal along with Gold Monetisation Scheme (GMS)
» While GMS proposes to ‘monetize’ India’s massive stock of physical gold, SGBs intend to convert the investment demand for physical gold into paper demand
» If subscribed fully in the first year, SGBs could result in saving of $2 billion on gold imports at current prices
The second issue is how attractive the banks decide to make the scheme. Prime Minister Narendra Modi has personally introduced these schemes and they have his backing, and the interest rate has been fixed at 2.25 per cent to 2.5 per cent on gold deposits to ensure the Scheme’s success. The problem here is that rather than encouraging individuals to part with the gold they already hold, it will encourage more canny entities to import large quantities of gold and deposit them with Indian banks as the returns will be high. If that happens, then the entire purpose of the Gold Monetisation Scheme is negated.

The third issue is what the banks can do with the gold deposited with them. According to the Scheme, the banks can lend or sell this gold to jewellers or other banks that are part of the Scheme. This is not as big an issue as the previous two points, but gold is not as fungible as cash. A cash deposit can then be given to anybody — everybody goes to banks for cash. But a gold deposit can only go to those looking specifically for gold. Thus, there is a non-zero chance of banks finding it difficult to match gold borrowers with gold depositors. That means there could be a situation where banks don’t have enough interest accruing to them to cater to the interest they have to pay gold depositors. It is an unlikely scenario, but is still worth thinking about.

The government also announced its >Sovereign Gold Bond Scheme, which seeks to encourage people to buy gold bonds instead of actual gold. In principle, this too is a good idea. Instead of buying physical gold, you are buying paper gold. The bond tenor is for eight years, with a minimum lock- in of five years. This seems fine, but the implications of its success need to be thought about.

The price of gold internationally is linked to the dollar. The new gold bonds, if made attractive enough, could become a substitute to rupee bonds. Basically, Indians will start putting their money into a type of dollar bond rather than rupee bonds. This might exert an upward pressure on interest rates.

To be sure, these are far from inevitable outcomes. They are just possibilities that the government must consider now rather than having to fix them once they happen.

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Printable version | Jun 21, 2021 12:10:16 PM |

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