Gold Monetization Scheme

India has an ambivalent relationship with gold. For consumers, gold is a prized asset, cherished as both an adornment and an investment. For the government, gold is a major contributor to the current account deficit, a challenge that needs to be addressed.

To reduce the amount of gold imports, and to make use of vast reserves of gold in Indian households, Mr Jaitley announced a gold monetization scheme that would help investors earn interest on the gold they own. The new scheme would allow the depositors of gold to earn interest in their metal accounts, Mr Jaitley said, adding that it will also help mobilize the idle gold in the country and put it into productive use. An estimated 20,000 tonnes of gold, worth over Rs 60 lakh crore, is held in the country. Banks and other agencies would also be able to monetize the gold deposited.

Gold Monetization Scheme

Working: When a customer brings in gold to the counter of a specified agency or a bank, the purity of the gold is determined and the exact amount of gold is accredited in his metal account. The banks would then lend this gold to jewelers at an interest rate higher than the interest paid to the customer. This way, gold stops being a dead asset and the vast amount of gold reserves lying in various households, temples, etc would enter circulation again, yielding interest.

Redemption: The customer will have the option of redemption either in cash or in gold, which will have to be exercised in the beginning itself (that is, at the time of making the deposit).

Tenure: The tenure of the deposit will be at least 1 year and with a roll out in multiples of one year. Like a fixed deposit, breaking of locking period will be allowed. A minimum deposit of 30 grams has also been fixed by the government.

This scheme though, is not a revolutionary new idea by any means. The previous Gold Monetization scheme of 1991 had a minimum deposit amount of 100 grams. Also the rate of interest at that time ranged from a meagre 0.75% to 1%. Many believe this low rate of interest to be the reason for its failure.

(Source: Voyage capital @ IIM-I)

This time, however, by reducing the minimum deposit amount to 30 grams, the government wants to attract households, rather than temples and temple trusts it was previously targeting.

To quote Ashok Minawala, director, Gem and Jewel Trade Federation: "The Gold Monetization Scheme is a wonderful concept of monetising domestic idle gold and brings it to the use of the industry to help reduce imports. The dynamics of scheme's design and interest paid to depositors will play a major role in the success of the scheme. The previous GMS failed due to many factors and merely a new packaging will not help bring the desired change of success”

To judge if the scheme has a future, one needs to analyze the gold demand drivers in India and the prevalent reasons for people buying gold.

Gold Demand Drivers in India:

• Combining Security and Beauty: Indian consumers view gold both as an adornment and an investment. According to a FICCI gold survey (2014), 62% of the samples of households surveyed buy gold considering it a safe investment. About 52% of households buy gold for adornment, About 34% households buy gold for dependent’s marriage
  

• Protection against Volatility: In India, as elsewhere, people want to hold gold to protect themselves from volatility and uncertainty. Consumers view gold as a protection against uncertainty. While 12 per cent of respondents would buy gold if the stock market was booming and 12 per cent would buy if it was falling, 22 per cent said they would buy gold in volatile market conditions.
  

• Part of the Family Budget
  

• A Trusted Asset
  

Advantages of the scheme:

• The gold kept in the lockers would yield an additional income of 1-3% per annum. This would be over and above the price appreciation of gold. This scheme would be immensely beneficial to people investing in gold as a commodity. In addition to the price appreciation, an annual interest.
  

• The regular income coming from these accounts might be further invested elsewhere to create a security for the household.
  

Disadvantages of the scheme:

• The gold in the metal account would exist in the form of gold bars. Any jewellery deposited in these accounts would be melted, with the metal account being credited for the quantity. A majority of households in India keep gold as jewellery which holds immense sentimental value. Often, a certain degree of social status is attached to jewellery. Conversion of this jewellery to gold bars might not be appealing to members of the household.
  

• The centers for depositing gold in this scheme may not be adequate in number, or might be scattered. The number of notified Collection and Purity Testing Centres (CPTCs) across the country at the time of the launch stood at 33 and the number of refineries at five.  There are almost no Purity Verification Centres in the eastern part of India, so a consumer in states like Mizoram, Meghalaya, Tripura, etc. will not be able to make use of this scheme.
  

• The process is lengthy and complicated for the rural household consumer and awareness of the scheme is also a big issue. Consumers will also have to incur fees if they choose to break the lock-in period (the gold deposit account is very similar to a fixed deposit account).
  

Implications for the Indian economy:

• Gold, which is generally considered an assets that sucks money out of the economic system (if the investment in gold is for the long run), will now be able to generate money flow in the economy without RBI intervening by its monetary policy. Due to a current boom being experienced by India, there is a need to increase the money supply to reduce the crowding out effect. This would also make possible lowering the gold imports.
  

• Indian financial & capital markets are considered to be under-developed. Gold Monetization Scheme would enhance the availability of funds with banks which can be given out as a loan or invested as private equity in start-ups, which is a big leap towards development of the financial and capital market of the country.
  

No one wants to see his long-preserved, family-inherited, emotionally-critical, piece of yellow metal lose its identity and ‘feel’ by melting it. Nobody seems to be happy with the lower rate of interest being talked about. (About 1- 2 %)

An analysis of buying patterns indicates that people (34%) buy gold for marriages (Stree-dhan). A metal account would prove to be a sound investment in such scenarios. Until marriage, the purchased gold would yield interest.

In my opinion, it would be wise for the government to offer a choice to the customer with respect to melting the ornaments. A differential rate of interest can be offered on melted and non-melted gold. This can be done while not compromising on purity assessment. Someone who isn’t willing to melt his ornaments should have to settle with a lower rate of interest.

In most Indian households, especially in southern states, gold ornaments are passed on from generations to generations as a family asset, closer to their heart. Parting with gold, by selling or pledging, is perceived as a social ignominy. It is a desperate step taken by an average Indian household in cases of extreme distress. Hence, it would be unwise to expect households to actively participate in any schemes that involve ‘melting’ the long-preserved jewelry.

The government believes that it could also curb tax evasion, as invoices would be required for customers depositing gold. However, for ornaments passed down generations, obtaining invoices would prove to be a problem. The government can partly address the problem to a certain extent by making invoices mandatory only for gold brought in the form of bars or coins and not necessarily for household ornaments.

- Abhijeet Singh