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How Gold Schemes Work for Indians and India

Published: 15th November 2015 08:28 AM  |   Last Updated: 21st November 2015 03:36 PM   |  A+A-

While launching the gold schemes Prime Minister Narendra Modi pointed to women empowerment implicit in gold. A day later he addressed the Delhi Economic Conclave. Noting India’s cultural affinity for gold, he made five points on the Indian gold economy. One, the ‘micro economic virtue’ of gold can become the ‘macro economic vice’ of high gold imports. Two, the gold schemes turn dead money locked in gold towards productive purposes. Three, gold schemes will provide, besides protection against inflation, modest interest without holding gold on hand. Four, when the schemes reach their potential, they will help meet the rational expectations of the people and moderate gold imports. Five, the schemes are reforms which have the potential to transform.

Feminine economics

What the Prime Minister did not say — but should have — is that the gold schemes unveiled are entirely indigenous in thought and conception. In the US/West masculine approach to gold, such a feminine economic view of gold would have been laughed out. The Indian economy is feminine in its soul. High savings, moderate consumption, risk-free investments and family structure — all point to the feminine character of the Indian economy. Modern economics is masculine. The gold schemes are in line with the philosophy of NITI Aayog. Modi’s cabinet directs the NITI Aayog “to zero in on what will work in and for India”. The Modi cabinet cautions the new thinktank that, “No single model can be transplanted from outside into the Indian scenario” and says, “We need to find our own strategy for growth”.

How do the three gold schemes work for the people at the micro level and the nation at the macro level?

Gold Deposits

The gold stock in India is estimated at between 22,000 tons to as much as 40,000 tons. In the last 18 years (1997-2015) alone, India’s gold imports have topped 15,000 tons. Studies show that a third of the imports, 5,000 tons, is for investment and not ornaments. It means that some 5,000 tons should be in the form of coins, bars or biscuits. The value of 5,000 tons is over $160 billion (Rs 11.5 lakh crore). This gold is precisely the target of Modi’s Gold Deposit Scheme.

The Scheme aims to draw the idle gold stock with the people into the monetary system. One can deposit gold into banks for fixed periods, like one makes fixed cash deposits. On maturity, the gold depositor gets cash, equivalent to the value of the gold at the time of maturity. The depositors of gold also get interest of 2.5 per cent per annum on the value of the gold at the time of the deposit. With the cash they get on maturity of the deposit they can buy the same quantum of gold they had deposited earlier. The benefit to them is they earn interest by depositing the gold coins or biscuits or bar.

What will banks do with the gold they get? They may sell or lend the gold for minting to the India Gold Coins Minerals and Metals Trading Corporation of India or sell it to jewellers or other designated banks or lend it to them. To whatever extent the government mobilises gold under the scheme, to that extent it will reduce imports and add to forex reserves.

Sovereign Bonds

Next is the sovereign gold bond scheme with different maturities. Under the bonds scheme the person who buys the bonds, in substance, buys gold. If somebody needs 25 sovereigns of gold for a wedding years later, instead of buying gold and putting it in a safe vault, he can buy the sovereign bond with a maturity of 10 years by paying the gold value today. On maturity he will get in cash the value of the gold at that time, so that he can buy 25 sovereigns in the market. He would earn interest of 2.75 per cent per annum which he could not have if he had brought gold instead of bonds. But the maximum limit upto which a single person can buy is 500 grams. The Reserve Bank of India issues these bonds on the strength of its gold reserves. The third is the India Gold Coins scheme under which the government sells gold coins of highest purity to the people. This is an open confession that the state was wrong in making smugglers to do it for decades.

Mutually supportive

The gold deposit, gold bonds and gold coins schemes are mutually and reciprocally supportive. How? By the deposit scheme, private gold becomes available with banks for sale as India Gold Coins or to jewellers or to be lent to other banks. Just as the deposit of monies into banks that is lent to borrowers, the gold deposited is sold or lent. If the banks sell the gold and the price of gold rises before maturity, the banks will, of course, have to shell out more money to the depositor. But, when the banks sell the gold, they lend the cash realised to borrowers at a higher interest of 10 per cent but pay only 2.5 per cent to the gold deposit holder. The margin is sufficient for both of them for buying gold in a forward market to protect against price rise and make profits. Under the bond scheme, the RBI sells the Sovereign Gold Bonds as gold equivalent. The 557 tons of gold in RBI’s vaults back the bonds it sells. As the bonds promise gold on a fixed date in the future, the buyers of gold need not buy gold today. This will dent the current demand and imports of gold. If India’s imports (which constitute a third of the gold mined in the world) fall, the world gold prices will fall and then the RBI can buy gold cheap and stock it.  Rise in gold prices will affect the RBI but it can buy gold in forward and hedge against losses. If prices fall, the RBI pays less on maturity. The interest rate on the bonds at 2.75 per cent being less than the bank rate of 6.75 per cent the RBI gains straight away. This is the wisest, most risk-free and profitable way of monetising the gold with RBI without losing the gold stock.

The three schemes put together are a package on gold — each one supplementing and supporting the other. The three schemes make gold equal to cash or cash equivalent security which will be more universally accepted in India than any stocks or bonds. The ready domestic demand for gold makes gold a golden asset. (Note that there is no such mass demand for gold in the West) Also Gold is equal to the Dollar, Euro and Sterling — namely foreign exchange. Gold is thus an asset and a security for the people and forex for the nation. The RBI earns some 2.5 per cent on foreign exchange holdings of over $300 billions and it earns nothing on its own gold stocks. Now it will earn on gold also, by issuing bonds against it. This will enable the RBI to increase the share of gold in its forex stocks, which will, in turn, scale up all three schemes.

Collectively the schemes have the potential to change the gold habits of the people — to access gold without possessing it. It will also institute a more India-friendly and feminine gold economy.

A Caveat: the government should not tax the difference between the value of gold when a person deposits gold or buys the gold bond and the value at maturity, provided the depositor or bond holder buys gold on maturity of the deposit or bond. This is because if he had bought gold and kept it, he would not be paying capital gains tax. Of course he should pay tax on the interest he receives.

The author is a well-known commentator on political and economic issues


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