Gold Monetization Scheme

Introduction

Indians love gold. The decision to purchase gold is more often than not an emotional decision. It is a quintessential item in most of our social customs and celebrations, festivals, marriages, anniversaries, religious rituals, etc. Even governments hold gold as an asset in their reserves (See Table 1). That is why the demand for gold is inelastic in the financial markets in spite of rise in its prices (See Figure 1). According to the World Gold Council, prices of gold in the past decade rose by 400% in the Indian Rupee terms but this did not have any effect on its consumption. In fact, its consumption, in quantity terms, registered an uptick by more than 70% in the last decade.^[i] Demand for gold in India has been ever increasing mainly due to its high “resale” value, demonstration effect, rising affluent middle class, a hedge against inflation and a safe haven for black money.

Table 1: Official Gold Reserves of Various Countries as of 31 March, 2015

Source: World Gold Council Report, 2015

Figure-1: Movement of Gold Price in the Past Decade

Source: http://goldprice.org/

Demand for gold constitutes of jewellery (56%), followed by investment purpose (27%) and industrial use (17 %).^[ii]  India imported 661.4 tonnes of gold worth $33 billion in 2013–14 and it is the second largest imported item after crude oil in our import bill. Import of gold (on net basis, after reckoning export of gems and jewellery), constitutes nearly 25% of India’s trade deficit in 2013–14. Hence, Government of India (GoI) restricted the import of gold through various measures, such as increasing import duty on the gold, stipulating additional conditions, such as 80:20 rule for imports,^[iii] etc. 

Though these preventive measures helped in bringing down our current account deficit to some extent, it ultimately resulted in unbridled smuggling of gold into the country through various channels. Illegal import of gold seized by the Indian customs authorities touched the highest point of Rs 690 crore during 2013–14. The Bharatiya Janata Party (BJP)-led government, which was elected in May 2014, relaxed some of the restrictions on import of gold that spiraled the import bill once again. Demand for gold in India through 2010–14 is shown in Figure 2. World Gold Council forecast demand for gold in India at 950 tonnes in 2015 (Jha 2015).

Figure 2: Demand for Gold in India (in Tonnes)

Source: World Gold Council Report, 2014

With a view to reducing the reliance on imports to meet the domestic demand for gold in physical form and bringing out the idle gold for productive use, GoI introduced the Gold Monetization Scheme (GMS) and “issue of sovereign gold bonds” vide its notification dated 15 September, 2015. Its main objective was to mobilise a portion of gold from the estimated gold deposits of 20,000 tonnes from the Indian households, temples, religious trusts, etc. The scheme that was launched in November 2015 was meant for alternative uses of gold for optimum utilisation of the “yellow metal” by the investors.

GMS and its Mechanics

The proposed GMS is a revamped version of the erstwhile Gold Deposit Scheme (GDS) and Gold Metal Loan (GML) which were launched in 1999 and 1998 respectively. As per the current scheme, the depositor of gold would be given a certificate specifying the amount and purity of the deposited gold, once the investor agrees to do so after fire-assay test (Government of India 2015) done by Collection and Purity Test Centres (CPTCs, certified by Bureau of Indian Standards).

Subsequently, the customer could submit this certificate to any designated branch of a bank to open a gold savings account in his/her name subject to fulfilling  “Know Your Customer (KYC)” norms. Accordingly, the customer’s account would be credited by the bank by “an amount equivalent to the quantity of standard gold of 995 fineness”, based on the prevailing market prices. The bank would bear the cost of fire-assay test in case of deposited gold, otherwise it would be borne by the customer. Minimum amount of gold that could be deposited under the scheme is placed at 30 gm in order to encourage collection of gold from small depositors.

GMS can be operated under three categories, namely (a) short-term deposit (for one to three years with a rollout in multiples of one year); (b) medium term deposit (for five to seven years) and (c) long term deposit (for 12 to 15 years).

While the short-term gold deposits are accepted by banks on their own account, medium and long term gold deposits are accepted by banks on behalf of the GoI. Interest and principal on the short-term deposits would be denominated in volume terms, that is, gold in grams. Rate of interest on these deposits would be decided by the banks based on the prevailing market conditions, international lease rates, etc. In case of the medium and long term deposits, interest would be denominated in the Indian rupees and would be decided by the GoI in consultation with the Reserve Bank of India (RBI). Though interest rates on these deposits have not been made public, industry sources indicated that it may range from 2%–3% per annum (PTI 2015b).

Use of Deposited Gold

The gold mobilised under short term deposits can be sold or lent by the banks to Metals & Minerals Trading Corporation (MMTC) for minting gold coins or to other banks or to jewelers. However, the gold mobilised under the medium and long term deposits would be auctioned by MMTC and the sale proceeds would be credited to the GoI’s account. The gold deposits mobilised by the banks under the scheme would be reckoned for maintenance of statutory liquidity ratio (SLR) (Reserve Bank of India 2015).

Merits and Limitations

The scheme has certain advantages viz, GoI proposes to make a provision for “Gold Reserve Fund” to address price and currency risks in case of medium and long term deposits. In other words, if the price of the gold increases at the time of redemption of the deposits, the government would bear the risk and the investor would get the benefit to that extent. Commercial banks, however, would provide safety on the short term deposits. As such, investors would not have any safety concerns in this regard. The deposits can be withdrawn prematurely subject to minimum lock-in period and payment of penalty. Therefore, the scheme offers liquidity on the gold deposits, of all tenures.

The scheme offers two kinds of return—fixed interest income on the gold deposit and capital gains, if any, through appreciation in gold price. Hence, the scheme is more attractive, in terms of returns, when compared with the investment in physical gold. As the government has stipulated minimum investment of gold at 30 gm (as against 200 gm in the earlier GDS of 1999) to lure domestic households, it would encourage investors to maintain gold in the form of financial asset rather than a physical asset.

Besides, the gold depositor is done away with “payment of rent” for storing physical gold as in the case of keeping physical gold in the bank’s lockers. However, at the time of redemption of gold deposit, the depositor may not get the same jewellery or ornaments, which she was holding earlier. The previous GDS of 1999 provided tax incentives, such as exemption from Income Tax and Wealth Tax. As per the notification issued by the GoI, the current scheme would also offer the same kind of tax benefits to the investors.

However, on the flip side, the scheme has features which may work against it. The jewellery held by the households in India is occasionally used; even if it is so, it is treated as a matter of status symbol and to showcase the wealth of a particular individual.  One can never be sure  how people will behave when it comes to physical gold. Introduction of gold futures on the Indian Commodity Exchanges has not deterred appetite for physical gold holdings.

Therefore, melting the jewellery, as proposed under the current scheme, will defeat the very purpose of the scheme. As gold is used as a store of wealth, many people, especially from the rural/semi-urban areas, who buy gold on various occasions or who wish to park their liquid cash in the scheme might not have proper record of  their income and Permanent Account Number (PAN), etc. In fact, most of the transactions in gold take place on “cash basis” and without any documentation.

However, Arun Jaitley, in his recent speech on 9 September 2015, categorically mentioned that the GMS is not “black money immunity scheme (PTI 2015a).”

Despite the proposed tax exemptions, very few investors are interested to disclose their income to tax authorities by depositing gold under the scheme. Hence, the scheme may mobilise gold only to a limited extent. While the previous scheme (1999) offered  relatively low interest rate of 0.75% per annum on the gold deposits, which was one of the reasons for its failure, the present scheme appears to be a better version than the earlier one. As the banks are free to decide on interest rates with respect to short term gold deposits, they may not be willing to offer higher interest rates on the deposits, in the absence of any incentives/regulations. Lower interest rates will not attract the investors, in any case. Hence, to attract more number of investors under the scheme,  the return (expected capital gain plus rate of interest) offered should be at least equal to or higher than that of the prevailing inflation rate (Reserve Bank of India 2013). One important point to note is that appreciation in value of gold may not happen in all market conditions.

In view of the above, only the gold that is held as “investment” might flow into the scheme. However, the quantity of gold held as investment is much lower than that of the gold held in the form of jewellery and other ornaments. At present, the number of CPTCs (Government of India 2015) located in India are only 331. Further, distribution of these centres is heavily skewed in favour of southern part of India (142, comprising 43 %), out of which Tamil Nadu has the highest number (57) followed by Kerala (38). Limited number of CPTCs are existing in the northern and western parts of India. Except for one centre in Assam, there is no other centre located in the North East. The skewed distribution of CPTCs will distort the nationwide implementation of the scheme and make the scheme confined only to certain pockets of the country.

Postscript—After the Launch

Narendra Modi formally launched “Swarna Bharat”—the formal name for the GMS on 5 November 2015.

Under this scheme, depositors have the option to take cash or gold on maturity, but the preference should be declared at the time of deposit itself. Once the option is declared by the depositors, it is irrevocable. In case of premature redemption, cash or gold will be given to the depositor, at the discretion of the bank.

In case of short-term deposits under the scheme, a leading Indian public sector bank indicated that interest rate at rate of 0.50% for one year, 0.55% for two years and 0.60% for three years. While the government is offering 2.25% on medium term deposits, it is offering 2.50% on long term deposits.

One reason for lower interest rates offered by banks under the GMS is that the international gold lease rates (the rates at which banks lend gold to jewellers) are hovered around 3%. Besides, the banks have to bear costs, such as storage, assaying and transportation costs.

The short-term deposits under the scheme have minimum lock-in period, say 12 months as per the notification of some banks in India. RBI allows Loan-To-Value (LTV) ratio of 70% in respect of gold deposits.

The scheme is attractive especially for the taxpayers as interest income from this deposit will be exempt from tax. Further, the scheme is exempted from the purview of wealth tax and capital gain tax (on appreciation in the price of gold).

Conclusion

Gold monetisation and gold bond schemes are progressive measures introduced by the government for optimum utilisation of gold by the investors and also towards reducing India’s current account deficit. While the GMS is targeted at harnessing the gold lying idle with the individual households, temples, religious trusts, etc, the GBS is designed to address the investment demand in non-physical gold. GMS might not be very successful since it does not address emotional attachment of investors with physical gold and does not have any significant improvement over the previous gold deposit scheme. Besides, appreciation in value of gold (capital gains) may not happen always. However, GBS is more likely to attract the investors’ attention in a big way as it offers higher returns than those of the investments in physical gold and the exchange-traded funds. Only time will tell whether the tax and interest rate incentives offered by the government will determine success of these schemes.

Notes