GOLD DEPOSIT SCHEME – WILL IT WORK THIS TIME?

The Government of India have brought out once again a Draft on the proposed Gold Deposit Scheme with the intention of monetising the idle househeld gold in the country, estimated variously between 18000 and 25000 tons. Before any comments are offered on the scheme, some basic attributes of this fungible commodity have to be kept in mind.

The annual consumption of gold in India fluctuates between 700 and 1000 tons. This consumption is in the form of coins or jewellery or bars. Domestic production of gold is neighbouring zero. So, if the official imports of gold fall short of consumption, the deficit is made up by unofficial channels with the lure of huge lucre going by the current import duty structure and as confirmed by the daily haul of smuggled gold at almost all international airports. The entries over land from neighbouring countries go unchecked and unreported.
The fact remains that the country adds to its household inventory at the rate of 1000 tons of gold every year! The moot question is if any scheme can reduce this size of annual consumption of gold in the country.

We should also look at the fact why only a miniscule of the household hoard comes out, that too, for only pledging? Jewellery makes up around 80% of the consumption. Of this, about 20% would be studded jewellery. These articles of jewellery are bought for occasions like weddings mostly and other family functions and personal gifting. Gold Deposit Schemes are not going to reduce this consumption a bit. Traditionally and for ages, jewellery or even other articles of gold, once bought by a family, are bought for ever! Barring, of course, plights of dire financial needs. Even on those occasions, mostly the route for encashment chosen is pledge. Here, the NBFCs are playing a crucial role. Currently, there is a cap on the interest that can be charged on the cash handout post pledge. But earlier, these companies were alleged to have made huge profits from the arbitrage between the interest outgo on their own public deposits and that collected from the pledging customers. It is also true that these companies are reported to have incurred huge losses, when it came to selling the unredeemed jewellery at a discount in the market owing to steep fall in gold prices. Other than those occasions, the jewellery is stored for ever as heirloom. This is one major reason why the earlier scheme announced by State Bank of India in 1999 with much fanfare did not take off.

With the rise in nuclear families and change in the outlook and perception of the younger generation about gold, we generally expected that consumption of gold would come down. But no such reality is seen on the ground. That means the traditional concept about gold jewellery holds sway among all generations, old or young. Gold is still treated as currency without any official scheme for monetisation. The ease with which this commodity can be encashed in the market or among friends and families for cash in times of need scores over all other commodities or articles, because of the unique size-value ratio of gold.

The current scheme is supposed to be a replacement of the earlier scheme of the State Bank of India, which is said to have failed for:

a. Low interest rate; and
b. Higher amounts of deposit

It is difficult to believe that these reasons alone were responsible for the flop. There is a section of the population which has in store more quantity of gold than the rest. If idling is the factor which should have driven deposits, any interest above zero should have been good enough, as no interest is earned at all on idling gold! The current scheme says that tax benefits as were available under the previous one are likely to be considered.

The crucial question is how is the scheme going to stop or reduce annual consumption of gold. If the consumption continues at the current rate, how is the scheme going to avoid imports? Will quantity equal to annual consumption be generated by the Scheme? And if the deposited gold is to be returned in kind, how is that going to reduce imports? But even if a small proportion of imports can be avoided, it is so much of saving in foreign exchange. The big question remains whether the perceived incentives can prevail over tradition and sentiments?

Presently, the householders resort to the following windows in times of financial needs:

a. Pledge the jewellery (to be redeemed later) for admissible cash with NBFCs. (This section clearly does not want to part with the jewellery acquired by them)
b. Walk into the nearest jewellery showroom (or the same one from where they bought) and sell for cash, after a hefty discount for wastage and making charges and administrative expenses, which vary from jeweller to jeweller. (This section is miniscule, as integrity of the method adopted for valuation is dubious)

The deposit scheme offers a totally different option of deferred encashment. That this was clealy a damp-squib in the previous scheme is proved by the failure of the scheme.

The current draft scheme has of course the following new features:

a. Utilising the deposited gold by banks to manage their CRR/SLR. This will release funds equivalent to so much of gold acquired into the monetary system.
b. Export of such deposited gold. This would bring incremental forex into the country.

On (a) above, it sounds imprudent to utilise the deposited gold to boost the CRR/SLR, as the gold mopped up is loaded with 10% of import duty and other taxes, making it so much costlier than international prices. Instead, the RBI can very well permit the banks to replace cash for such ratios with gold imported duty-free.

On (b) above, again export of such gold would be a costly proposition, unless draw back of duty and other local taxes is allowed on such exports, as the export realisation would be at international prices sans these elements.

All these could be realised only if there is adequate interest among the public in the Gold Deposit Scheme. With changes in the lifestyles, especially among the younger generation, giving more priority to items of luxury and housing, let us hope that gold is losing its sway as the most preferred spend. This would at least reduce consumption, thus reducing imports even if the idle gold does not get monetised under the scheme. At the same time, with the passage of time and with the same tax benefits being ‘considered’ to be offered as previously, one can still expect that the new scheme generates interest.

The scheme has to take care of an important aspect, which has been ignored. The scheme provides for return of gold in kind on maturity. As the country has to totally depend on imports without any domestic production, the maturity value is fraught with fluctuation of both the gold price as well as the rupee value, on the date of maturity. This can be avoided only hedging both the values. This would entail extra cost and has to be factored into the margin available to the banks. If the future prices in the international markets show huge contango and the forward premium for rupee is high, then the scheme would become unviable, as the banks will not be able to return the deposit in kind without incurring huge losses. Further, the RBI may have to permit the banks to buy forward in the international commodity exchanges. If the gold has to be returned later, it only shifts the imports to a later date, making no difference to the overall quantum of imports.

But the scheme can be made more attractive by including a mechanism for outright sale by the public through official channels. Currently, the banks are not allowed to buy any jewellery or gold bars and there is also no standard mechanism among the private jewellers to ensure a fair price to the seller. Each jeweller has his own thumb rule to knock off making charges and wastage from the jewellery offered and purity from the gold offered for sale. While I said earlier there is a section of population which walks into the nearest jewellery showroom to encash their jewellery and other articles of gold in times of need. There is also a large section of population which does not want short-changing by the jewellers and hold back, though gold as a store of value has lost its charm. For the last more than three years, gold as an instrument of saving, does not offer any return at all. The bull run was over long ago.(Please see the table below):

1

As the banks offer an interest rate ranging from 8 to 9% p.a. on deposits, it is my strong opinion that if there is a Govt backed scheme for buying jewellery and gold bars, there would be huge interest. The investment component in consumption which was around 30% of the total consumption until about 3 years ago has totally vanished today, with international prices touching some times below production cost levels for quite a few gold mines and those who have invested in gold earlier would certainly grab any Govt. backed scheme to sell their gold and invest the proceeds in bank deposits, which yield attractive returns. And such buys can be recycled by the banks and other agencies either for outright sale or lending, which would really reduce imports (as there is no need to make any fresh imports to return such gold to the seller) and at the same time bring out the household gold.

All the banks can open special counters for this purpose. Jewellery can be melted and refined and made into pure gold bars. Bars tendered by the public also would need a recheck for purity. These functions can be easily handled by the country’s only world-class, LBMA accredited Gold and Silver Refinery, MMTC-Pamp, who can open assay centres across the country, as they have the best of trained human resource and the latest tools and technology for faster, fool-proof and cost efficient operation. Along with the banks, MMTC-Pamp can also be allowed to buy jewellery and bars from the public and relend and resell such gold in the domestic market. The banks and the refinery can charge a nominal transaction cost to cover the melting, refining and other logistic expenses and their margin and buy the gold at prevailing domestic prices. The State Governments should be persuaded to exempt such purchases from purchase and sales tax, as the gold has already suffered taxes earlier.

The Central Government should extend all the tax exemptions to such gold purchased, as was announced in the previous scheme. Now that the Finance Bill requires a Pan Card for all transactions above the value of Rs.1 lakh, there would be no need for any further due diligence. After all, the gold coming out of the households has already suffered all taxes, including income tax, as they have been bought from the householders’ income in the past. Offer of huge quantities by a single individual in one lot, which raises suspicion, can however be examined deeper for satisfying on the rightful ownership.

Besides reducing import to the extent of procurement from the market, the banks/refinery and the jewellers would stand to gain substantially if such gold is given to the jewellers on INR loan for a fixed period of say 3 to 6 months. The interest rate would be so attractive as to give adequate margins to both. This is because, there would be no need to take any forward cover either for the gold or for the rupee, as the repayment of the loan would be in INR and the gold price would have been fixed at domestic rates on the date of lending. Without the need for forward cover, interest rates can be as low as 5 to 6% p.a. leaving a handsome margin for both the lender and borrower. In such a situation, the jewellers would avoid imported gold where the cost of borrowing would be much higher. The banks and MMTC-Pamp Refinery can lend the gold against the security of a cash deposit equivalent to full value of the gold lent. Cash deposits, converted into Fixed Deposits with banks, would increase the profit margin of the borrowers, as the cash deposits has an arbitrage window and would earn interest much more than the interest liability on the borrowed gold. The banks would also report a higher growth of their deposit portfolio. This would substantially reduce imports, provided the entire cycle is kept simple, foolproof, fast, dependable and cost-efficient. With MMTC-Pamp Refinery being the nodal agency for production and certification, these functions should not be a problem at all. Reduced imports mean saving of foreign exchange. Saved is earned! The Government should give this an aggressive try to monetise domestic gold and reduce imports.

Disclaimer: Views are personal and not the views of the publisher.

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