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Photo: Bloomberg
Photo: Bloomberg

Tweaking the gold schemes

The gold bond scheme and gold monetization scheme can help deepen the financial sector. We can't afford these to fail

India’s gross savings rate peaked at 38% of gross domestic product (GDP) in 2008. The share of financial savings at 51% was also a historic peak in that year. Since then, the country’s savings rate has dropped to about 32%. Most worryingly, of this declining share of savings in the GDP pie, financial savings have gone steeply down to 30%. The non-financial savings of households mainly go into land and gold. These are unproductive and illiquid.

The increase in demand for gold in recent years perhaps reflected a rational response to high inflation. Further, most households have small quanta of savings. For them, apart from gold, there is no equivalent asset that can provide an inflation hedge and provide a parking space for long-term savings.

The National Pension System (NPS) is no match to the allure of gold, even for long-term savings. Blame it on lack of financial literacy, lack of a distribution, lack of trust in the capital markets or just lack of rationality. The NPS has miles to go. Equity and mutual fund distribution has not moved beyond large cities.

The perverse impact of this insatiable demand for gold on the macroeconomy can hardly be over-emphasized. Between 2004 and 2014, India spent $176 billion for the import of gold.

In that same period, the total inflow from foreign institutional investors was just $130 billion. The foreign exchange outgo to purchase gold (not meant for re-export of jewellery) is a serious drain on the economy. It leaves that many fewer dollars for the import of submarines and fighter jets.

Anything that can reduce the gold-related foreign exchange haemorrhage is urgently needed.

There are two aspects to this. First, how do we convert the huge stock of gold (estimated at around 22,000 tonnes) into financial savings that can go into productive investments? Secondly, how do we reduce the import of gold? The gold monetization scheme (GMS) addresses the former, and the gold bond scheme (GBS) addresses the latter. Both are voluntary and not coercive.

Contrast this with Executive Order 6102 by then US president Franklin D. Roosevelt in April 1932. That order basically made it illegal to own gold in the US. Even in freedom-loving America, such a draconian order was necessary to mop up the private hoarding of gold and convert it to financial savings. This measure contributed significantly to the recovery from recession. This statute of criminalizing the possession of gold was comprehensively annulled only in 1975. By comparison, India is only gently trying to persuade its population to reduce its addiction to gold.

GMS has collected a few hundred kilograms of gold from various temple trusts, such as Siddhivinayak and Shirdi of Maharashtra. Tirupati, Guruvayoor, Sabarimala, Padmanabha and Meenaskhi are expected to follow suit. It reduces the cost to temple security, earns them a regular income and helps fund more of their social activity.

But GMS is hampered by the fact that you have to physically get the gold tested. The number of testing centres is too few. The first tweak is to expand this set substantially. For instance, jewellers and bullion traders can act as collection agents for GMS. There are 350,000 such traders, and so long as the Bureau of Indian Standards certifies them, they should be made eligible.

The second tweak is to dilute the know-your-customer (KYC) norms. Since the government already sells investment products such as the Kisan Vikas Patra (KVP) through post offices, similar KYC should apply to the GMS and GBS. For instance, a permanent account number (PAN) and identity proof should suffice. At least till the schemes gather a significant quantity of gold, KYC should be less stringent.

The third tweak is regarding disclosure of the source. The industry association of jewellers has recommended that for quantity less than 500 grams, especially from women, the source of the gold for GMS should not be asked. This can be considered as traditional stree-dhan, the woman’s traditional right. Such dilution of KYC both for GMS and GBS should not be interpreted as an amnesty for black money. In any case once the gold is monetized, it has entered the formal financial sector.

The fourth modification is for the bond scheme. It is literally a substitute for gold. But it needs a massive publicity campaign. Just like insurance, such investment products are sold, never bought. You need a push. Imagine GBS marketed as Asli Gold by a brand ambassador like Amitabh Bachchan.

The fifth tweak is that GBS should sell at a small discount to the daily spot price of gold. There should be no time gap between the RBI announcing the official rate and the actual sale at distribution outlets. GBS or demat gold should be made available on tap anywhere, much like buying mutual funds or KVP. It should be made exchange traded—that will add to its liquidity. It can be pledged as collateral too.

The sixth tweak is to give tax relief, at least for now, till the two schemes gather momentum. For instance, if the bond is held for more than three years, it should be exempted from capital gains and income tax.

Both GBS and GMS are big steps toward deepening India’s financial sector. We can’t afford these to fail. These are voluntary and not coercive. Even a 10% mop-up of the country’s stock of gold (through temples and individuals) is equivalent to mobilizing resources worth four years of foreign direct investment. Gold monetization is certainly not an alibi for black money amnesty. Similarly, the popularity of the GBS will be an indicator of growing trust in a sovereign instrument.

Ajit Ranade is chief economist at Aditya Birla Group.

Comments are welcome at views@livemint.com

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