Home / Opinion / Onshore dollar bonds: a potential ‘Make in India’ initiative

An interesting instrument envisaged in the budget is the issuance and management of gold bonds to Indian residents. The annual consumption of gold In India for investment purposes is estimated to be 200 tonnes. The estimates are derived from the purchase of bars and coins in India, other than jewellery. Indian gold investors could warm up to such bonds.

In Goldman Sachs Asset Management’s experience, the gold investment demand is also driven by the need to invest in instruments that beat inflation and invest in proxy foreign currency. As the Indian saver does not have easy access to invest or save in a foreign currency, one typically ends up buying gold, even though taking foreign exchange exposure is the primary reason. This effectively creates a physical implementation of “Quanto Gold" that can be eventually converted to any desired currency. This, however, results in unproductive investments for the Indian economy as a whole and, therefore, the success of gold bonds could be very helpful in turning unproductive investments into mainstream productive assets. These instinctive linkages between domestic gold demand and the currency markets or capital account is something that has been well understood by the government and the Reserve Bank of India (RBI), and articulated in the Tarapore committee’s report on fuller capital account convertibility (2006).

The gold monetization scheme is expected to replace the gold deposit and loan schemes initially introduced in 1999-2000. The fact that banks and other dealers will also be allowed to monetize such gold will be a huge positive for the scheme. But this step would require a great deal of planning and proper legislation. The required data and knowledge is there but needs to incorporate various issues, such as gold assaying requirements, allowing cash deposits in the scheme, certification being made available in a dematerialized form and a reduced minimum deposit size. The whole scheme should be made seamless between the investor and borrower. Today, lending to banks is difficult due to statutory liquidity and cash reserve ratio requirements. There are also problems relating to import duty and local body tax in the calculation of the gold price for gold deposit and loan schemes.

Sovereign gold bonds would be the best way to reduce physical gold consumption in India as investing in a sovereign issuance would be preferable for investors versus taking on the credit risk of a bank or any other entity. The K.U.B. Rao committee report of RBI (2013) has explored potential issues in detail, including potential mechanics of a gold deposit scheme that could be offered to a broad retail audience, using a “Bullion Corporation of India" to be set up by the government. It will indeed be a huge milestone for the country, if a vibrant dematerialized gold market can finally be developed over time based on findings of this report (as well as those by prior committees that were set up by the government on this subject).

Given that most Indians buy gold to hedge against inflation and also to diversify into foreign currency, another instrument that could be considered is issuance of dollar denominated bonds to resident Indians. A dollar bond, issued by the government of India, could help Indians invest in foreign currency out of the $125,000 annual limit. Currently, the process is difficult for most Indians, especially for those whose threshold amounts are low.

There is a large population with the need to hedge forex funds for their children’s education, travel and other similar expenses. They could have a better product than gold while allowing the Indian government access to these funds and reducing the demand for gold and for gold hedging (of the gold bonds). The instrument could also attract other latent pockets of demand, which are currently serviced offshore, such as encouraging exporters from repatriating their earnings quickly and having them park the proceeds in these bonds, while providing an alternative for small importers to hedge on the currency futures market.

The instrument could also incorporate learnings from onshore dollar bonds that have been launched in Indonesia and the Philippines as mechanisms to grow their domestic financial markets.

A big collateral advantage would be the start of sovereign borrowing in forex, but limiting it within the domestic market. Thereby, this market would be within the greater control of the government or RBI, unlike the current offshore rupee non-dollar forward (INR NDF) market, where the government has little oversight.

The next step could be to allow non-government entities to issue dollar-denominated paper (currently borrowed through the European Central Bank) and then allow foreigners to invest, thereby completing “bond-currency-derivative" linkages, which have been missing in Indian financial markets.

All these policies could lead to Indians having access to international investments, development of forex and forex bond markets in India while helping the borrowing to be used by the government, rather than being invested abroad. Indians could get diversification, while the government gets funds at a marginally lower cost. At the same time, the instruments could reduce reliance on offshore currency markets and effectively become the “Make in India" initiative for the Indian financial services industry.

Sanjiv Shah is chief executive officer, Goldman Sachs Asset Management (India) Pvt. Ltd.

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