With a slew of festivals encouraging gold buyers, there is little wonder that Indians are the biggest hoarders of the yellow metal in the world. Rough estimates suggest that nearly 20,000 tonnes of gold is locked up in Indian households. That’s money locked in an asset which does not yield any returns. In order to put this gold to good use, the Narendra Modi government is launching the Gold Monetisation Scheme (GMS) as announced in the Union budget. Ironically, however, just a week before the launch of a scheme which aims to mobilise gold held by households and institutions, Modi will introduce gold coins bearing the Ashoka Chakra on it.
The coins are aimed at meeting demands during Dhanteras, which normally sees gold buying, even in small quantities, in many households. The idea behind the launch is to introduce an ‘Indian’ gold coin for captive consumption rather than the imported ones.
But what enthuses bankers and gold market stakeholders even more is the success of the GMS. The new GMS replaces the existing 1999 Gold Deposit Scheme, in which the minimum gold that could be deposited was 500 gm – an amount very few households could afford. No wonder then, that the scheme failed. The new scheme allows for deposits as small as 30 gm. However, there are certain issues which could hamper the success of the current scheme.
We shall look at some of these issues before discussing the benefits of GMS.
Show Me the Money
- Banks borrow gold from households and lend to govt/jewellers
- Households lend gold to the bank at 2.75 per cent interest
- Interest charged by banks from govt/jewellers is higher
- If successful, nearly 20,000 tonnes of gold valued at over $700 billion can be put to productive use
- It’s also beneficial for households as gold in the vault yields zero or marginal returns
Speed Breakers
Price fluctuation risk: Banks will play an important role in the success of the scheme. They will collect gold from households and lend it to jewellers or the government. Banks will pay lenders (households) an interest of 2.75 per cent and charge higher rates from the borrower. The difference between the two is the profit that banks will keep. The problem is that while lenders have the option of claiming interest rate either in rupees or its weight in gold, banks have no such flexibility while charging the borrower or the government. This exposes banks to gold price risk.
After objections by banks and the RBI, the government made some changes to the scheme by creating a Gold Reserve Fund which will absorb the risk of price fluctuation. The risk however has not been transferred from the banks to the government. If there is a huge variation in gold prices the Gold Reserve Fund might be too under-capitalised to take care of interest payment.
Few check points: According to government data there are only 331 Assaying and Hallmarking Centres in the country. Despite this already small figure, the government will select the ones which meet the Bureau of Indian Standards’ (BIS) specifications, and only those will be allowed to act as collection and purity testing centres. The small number of centres can be a logistical nightmare.
Emotional attachment: The gold owned by households is usually in the form of jewellery which has a high emotional value. When a household pledges gold with a money lender or bank, one of the first things they ask is if they will get back their own jewellery. The government might have thought through most of the financial and operational parameters, but this emotional factor can affect large scale participation. Only institutions which do not share an emotional attachment to jewellery would not mind parting with their gold.
Big Plus for the Country
If successful, the benefits of GMS will far outweigh any issues with the policy. The country will be the biggest beneficiary, as potentially nearly 20,000 tonnes of gold valued at over $700 billion can be put to productive use. The government plans to use this gold, rather than importing it, and earn foreign exchange by exporting jewellery. Gems and jewellery account for nearly 12 per cent of India’s export.
Smaller Gain for the Lender
Post the advent of financial markets, gold lost its charm as an asset class. Historically, financial markets and real estate have offered much higher returns than gold. Though the interest rate of 2.75 per cent may seem low, it is better than the marginal or zero return one gets from keeping gold in the vault. The sweetener for the gold bug is that interest can be availed in the form of gold.
(The writer is a Mumbai-based market analyst.)
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