BackWill gold monetization scheme work for depositors, banks?
If the guidelines are implemented, it is likely that the scheme will not see much traction
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On 19 May, the government of India released the draft guidelines for the gold monetization scheme (GMS). The scheme was announced by finance minister Arun Jaitley in his budget speech in February. As noted in the draft, the scheme has three basic objectives. First, to mobilize gold held by households and institutions in the country. Second, make gold available on loan from banks to jewellery businesses. And third, to reduce dependence on imports. Will the scheme be able to fulfil these objectives?
For the record, India is one of the largest consumers of gold, and imports 800-1,000 tonnes every year. In fact, the high gold import was one of the reasons for high current account deficit in recent years, which resulted in a crisis-like situation in the second half of 2013. India imported gold worth $56.5 billion in 2011-12 and $53.8 billion in 2012-13. Imports came down to $28.9 billion in 2013-14 because of restrictions and fall in international gold prices. Since India imports large amounts of gold, bills for which have to be paid in foreign exchange, it has been suggested in the past that ways should be devised to recycle the gold stock available in the country in order to save foreign currency, which will also reduce vulnerability in the external account.
In the 10 years to 2013-14, India imported gold worth about $280 billion. Theoretically, if we had not imported even a single ounce of gold in the past 10 years and saved all the foreign currency on this account, and assuming it was not spent on other imports, the total foreign exchange reserve of the country today would have been about $630 billion; the actual level is about $350 billion.
The finance minister in his budget speech had also announced a sovereign gold bond, details of which are awaited, though the idea again is to create an alternative financial asset for gold investors and cut imports.
However, in the case of GMS, if the guidelines are implemented, it is likely that the scheme will not see much traction because of the following reasons.
First, according to the World Gold Council, in the past decade, 75% of the gold demand in the country has been for jewellery. Further, two-thirds of this has gone to the rural areas. And this is the problem. If the scheme has to take off in a meaningful way, households will have to participate. While an attempt has been made to attract small depositors by keeping the minimum deposit at 30g, they may still not come forth. According to the guidelines, gold will have to be melted to be monetized, which households may not like.
According to the draft, the gold (jewellery) will first be tested for purity, and after the consent of the customer, it will be melted. If the customer is willing to deposit the gold under the scheme, she will be given a certificate by the collection centre, stating the amount and purity of gold, and which will have to be produced in the bank for opening the gold savings account.
Although depositors will have the option of taking back gold after the maturity period, the purpose will not be served as it will entail a loss in terms of making charges of 10-25%, and the same will be have to be paid by the depositor again if she gets the gold converted back into jewellery.
Also, in India, especially in rural areas, people tend to attach social and sentimental value to gold. Unless the gold was bought purely for investment purposes, it is unlikely that the households would be willing to go through the process. If the jewellery was bought for usual purposes, it is unlikely to reach the bank.
Second, according to the guidelines, banks will have the freedom to decide the interest rates on gold deposits—the gold that people will deposit after having gone through the process described. So, basically, the fate of the scheme will depend on banks. If the interest rate is high, the scheme may see some traction; but if it’s low, things may not take off. According to reports, banks may not be willing to offer a higher interest on this account. Further, handling of physical gold will entail costs, which will affect the rate of interest offered to the customers.
Third, in order to incentivize banks, the draft guidelines say that they may be permitted to use gold mobilized under the scheme for cash reserve ratio or statutory liquidity ratio (SLR) requirements with the Reserve Bank of India. Again, this may not help. Over the past few years, due to poor demand for credit, the banking system is holding government security in excess of what is mandated under the SLR requirement.
Apart from this, since the depositor will have the option of taking the principal and the interest earned in gold after maturity of the deposit, banks will get exposed to the risk of fluctuation in gold prices, which they will need to hedge. Therefore, it is possible that banks may be reluctant to push this scheme.
Although the intention of monetizing gold stocks in the country—which is estimated to be at over 20,000 tonnes—is good, the operational rules, as stated in draft guidelines, may not lead to the desired outcome.
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