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Government`s New Gold Schemes - A View

Posted On Friday, Nov 06, 2015

The honorable prime minister yesterday unveiled the much awaited set of gold schemes each serving a unique purpose primarily aimed at bringing out the gold holdings held by households and institutions and using it productively at the same time trying to discourage further physical buying of gold in order to reduce the pressure on India’s current account.

There were three measures announced:

Gold Monetization Scheme:
This scheme is aimed to bringing the idle gold reserves out from private holding and to be used more productively by bringing them into the financial domain. It is a very important scheme from India’s perspective. However the success of the scheme lies in how fast they can improvise the scheme to attract and gain confidence of the masses. A lot of awareness is required. We are perhaps trying to draw a leaf out of Turkey’s books where it has been a huge success. However, the important difference between both lies in the approach. In Turkey, the depositor of gold walks in to a bank branch with whom he has been dealing for years and his other savings lie there. Therefore, the depositor has the much needed trust and confidence in the institution with whom he is going to deposit his gold with. However, in the Indian context, the customer has to walk in to an unknown collection center to verify and deposit his gold. It is therefore not going to be an easy to task for the holders of gold to part away with their holdings and in the initial phase deal with an unknown entity.

Secondly, the problem of under-caratage in India is well known. When the depositor goes with his jewelry which is marked as 22 carat he comes to know that it’s much lower in purity and therefore it will fetch him lower relatively than his perceived value, and also relatively lower than what was paid at the time of purchase. In such cases, there is bound to be a conflict.

Thirdly, the option to select the mode of repayment at the time of deposit may be done away with as customers would not know that 8-10 years down the line, would they require the gold or cash instead. The depositors should be given the option at maturity to select the mode of repayment.

Fourthly, the interest rate offered could have been higher, somewhere close to at least 4% to entice holders of gold to part away with their holdings. The current rate offered of 2.25-2.5% may fall short of expectations.

In order for Gold Monetization Scheme to succeed, banks have to play a pivotal role and it would be better if the customers walk into a banking entity in which they have the trust and confidence - an outcome of dealing for all the many years. Also, awareness and educating the masses is important regarding the scheme.

Sovereign Gold Bond:
A Sovereign Gold Bond is a paper alternative to physical gold, to address the investment demand for gold in India, and thereby reduce physical demand for gold and in turn reduce gold imports.

Unlike Gold ETFs, the bond will not be backed by gold, but by a sovereign guarantee. The investors will get interest on the gold bond at 2.75% which will be subject to tax, and on maturity they will get the prevailing value of gold at that time.

It’s a good alternative but the following issues will run through investors` mind while deciding to invest in them

1.First and foremost, the liquidity aspect. If I need to sell these bonds before maturity will there be enough liquidity on the exchanges where they are proposed to be listed?
2.Pricing of the bonds may be an issue – Like for the current bond being announced, the price for the bond is fixed at Rs. 2684 per gram for 999 purity. However, the current rate of gold is lower than the issue price and therefore it would make investors think about overpaying. The pricing for the bonds should be dynamic i.e. investors get the price on the day of investment or the price on the allotment day – this will help resolve this issue.
3.There is a cap of 500 grams annually and therefore investors wanting to invest more in bonds will not be able to do so.
4.The interest on the bond will be paid on investment value. Even, if the gold prices move up, the yield will be calculated on investment value and not on the mark to market value. Therefore, the yield calculated from the prevailing market price may turn out to be lower than the mentioned 2.75%, in the event that gold prices move up.

India gold coin:
This is a sovereign gold coin. Many countries have their sovereign gold coins. India largely imported gold coins for consumption, so this India gold coin comes at a right time when the government is pushing the concept of Make in India.

More so, it aims to bring in a measure of standardization as far as the purity of gold and also pricing of gold goes. The government can also channelize gold collected in the Gold Monetization Scheme towards minting of these coins.

This three-pronged approach was much needed from India’s perspective. However, there are some limitations on certain aspects which need to be proactively addressed as these schemes develop. Government and banks need to do a lot of work towards education and awareness of these gold schemes for it to succeed. Also, an entity like a Gold Corporation is the need of the hour to ensure smooth implementation and coordination of these schemes. It would increase the chances of success when the shortcomings can be easily addressed by a focused entity. Not only that, India could further develop its gold market and use its strength to become a hub for gold trading, refining, jewelry manufacturing etc as far as the global gold market is concerned. India has the potential and expertise in gold and also being the largest consumer and holder of gold, this is certainly possible – an entity like Gold Corporation can help in a big way by creating the right policies to help develop the market.

Data Source: Bloomberg, World Gold Council

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