The Indian government has announced the gold bond and the gold monetisation schemes with great fanfare.
The aim is to utilise the approximately 25,000 tonnes of gold in the country and channel them into financial savings or instruments so that annual gold imports of 800-1,000 tonnes come down.
However, as is the case with most of the government schemes, the actual rules, regulations, KYC (know your customer) requirements, capital gains and low rates of interest of 2.5% among others, are likely to make these schemes unworkable.
Wearing gold jewellery and gifting it during weddings are part of the Indian tradition. Over the last 10-15 years, there has also been a huge increase in buying of gold in the form of coins and bars for two reasons. First, parents prefer to use their current cash flow to accumulate gold for their children’s marriage. The second has been investment buying—a result of increasing gold prices over the last decade despite the crash in equities and real estate. Around three years back, gold prices started to fall or stagnate.
The total value of gold in India at the current prices will be in a range of $800 billion to $1 trillion.
Why the current scheme is unworkable?
- The government and its officials have gone at length to explain that this is not an amnesty scheme and as such anyone disclosing their gold runs the risk of getting the infamous tax department after them.
- While most of us staying in cities and saving money in banks might still think that possibly making 2-2.5% on idle gold makes sense, for a majority of Indians as well as the informal sector, the cost of borrowings varies between 12% and 24% per annum depending on the place, need or vocation. As such this rate of interest is unlikely to attract anyone.
- As far as gold in the form of jewellery or even coins goes, the making charges are in the range of 2-10% as such it makes no sense for people to surrender gold in this form to the Reserve Bank of India (RBI) or the government. Such monetisation will be an absolute no starter.
- The only target segments that are likely to oblige the government could be some large temple trusts like Tirupati.
- It is estimated that around 20-30% of the total annual demand is for investments. Now the government and those positive on the gold bond scheme might assume that some part of this might get into gold bonds. There are two issues with this. First, a lot of it would be cash purchases and second when the RBI issues gold bonds, who takes on the price risk of gold? Will it not have to go and hedge by buying gold and in turn make the entire exercise futile?
Why a gold amnesty scheme would work better?
There is a huge amount of gold with Indians that has either been bought in cash or is there as ancestral holding which has not been declared as official holding. Gold and land have been the two main assets that have been used to deploy unaccounted cash in India.
A majority of gold where the source cannot be proved cannot form a part of the above plans of the government. In my view, a one-time amnesty scheme makes more sense.
Unlike a normal amnesty scheme, where the undeclared income is converted into white by just paying tax on it, the gold amnesty scheme will have to run differently as no one will like to pay upfront tax on the value of the asset that they are declaring.
I believe that the best way to run this scheme will be as follows:
- As the first step, gold will be declared by the holders to the government and the government will, in turn, issue bonds to the people who declare the gold. The yield on these bonds will be around 3-4%. On redemption, the amount that is paid will not be taxed in the hands of the holder. When compared to an ordinary 10-year bond—which effectively yields 6% post tax—there would be a 2% gap which in a way is the penalty paid by the investor for using black money to buy gold in the first place.
- At the second step, the government will have to decide what to do with the gold that it has got. One option would be to sell it to the RBI, which will then add this gold to the foreign exchange reserves and in turn given the equivalent money in rupees to the government.
- The other option will be for the RBI to sell this gold in the international market, realise the money in US dollar and provide the equivalent amount in Indian rupees to the government.
- The last option will be for the government to open up the gold so bought for purchase by the Indian public. This will cut down imports of gold significantly.
Any of these options will boost and build the foreign exchange reserves and stabilise the rupee.
Now, the question is how much gold will the government need to get to make a meaningful impact. At current prices, one ton of gold will be approximately worth $40 million. As such 25 tonnes will be required for $1 billion. The government needs to target a quantity of 1000 tonnes for an amount of $40 billion. This is 4% of the current holding of gold in India.
Given that the government will be able to realise the rest of Rs2.5 lakh crore in ten-year money, it will also remove crowding out from the economy. This will give a significant leeway for the Indian economy till the time till the government takes steps to resolve that current account deficit problem in a more sustainable manner.