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A gold scheme guide for common person - Outside View by S.S. TARAPORE
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A gold scheme guide for common person
Nov 16, 2015

On November 5, 2015, the Government of India introduced three schemes on gold: (i)Gold Monetisation Scheme (GMS) (ii) Indian Gold Coin Scheme (IGCS) and ( iii) Sovereign Gold Bond Scheme (SGBS). In many ways these schemes are path-breaking and, if operated properly and marketed well, could bring about a fundamental change in the Indian gold economy.

Is India's Obsession with Gold Rational?

Policymakers, opinion makers, analysts, bureaucrats and politicians all claim that Indians have an erroneous obsession with gold and as a result gold imports account for a large part of the balance of payments current account deficit (CAD). The official approach since 1939 has been to tighten the import regime in the hope that the drain on India's foreign exchange reserves would be contained. Whenever the gold import regime tightened, illicit imports of gold increased. Since 1992 the gold import regime was gradually eased and illicit imports came down. When the CAD came under pressure in 2013, the gold import regime was tightened and illicit imports increased. The upshot of all this is total annual import of gold (official and illicit) is now around 1,000 tonnes .

Those who shout from the rooftops that holding of gold by the common person is irrational themselves hold gold. Over the long period gold comes up trumps as it gives a return which no other instrument can provide. While equities may give a better return the common person has no knowledge of what stock to buy. The common person is indeed rational in opting to hold gold. Consumer preferences cannot be changed by coercion. To reduce demand gold more attractive financial instruments have to be provided to savers.

The package of three gold related instruments introduced on November 5, 2015, could be a major breakthrough. These three instruments need to be assessed from the viewpoint of different investors and in particular the common person.

GMS

The essence of the GMS is that holdings of gold are to be assayed, melted down and a certificate given to the holder of the amount of gold held by the depositor. The potential investor has to first deal with an unknown assayer and then place the gold deposit with a bank. Such a scheme is not meant for the common person as their holdings are invariably in the form of jewellery. Melting jewellery at the first stage and collecting gold on maturity and then reconverting into jewellery involves heavy costs and hence individuals with modest gold holdings should stay away from this scheme. This scheme is, however, attractive to Temples and Trusts which have large gold holdings of bars and ingots. For these holders an interest bearing medium/long-term deposit would be attractive. From the authorities viewpoint the gold can be lent to users of gold in India at higher interest rates to be repaid in gold (or the price of gold on repayment). This could significantly reduce import demand.

IGCS

For the IGCS to succeed, the GMS

scheme should be a success. If the IGCS is successful the demand for imported coins would come down. Small holders should not go in for this scheme as a hefty premium is charged.

SGBS

The SGBS has the greatest potential of being able to dissuade small investors from holding gold in physical form. The investor invests in bonds rupees equivalent to a certain amount of grams of gold, with a maximum of 500 grams, and on maturity the holder gets back an amount for the invested number of grams in rupees based on the price of gold on maturity. The proposed scheme is promising in that it can shift the demand for physical gold to paper gold and thereby reduce imports.

There are, however, some serious operational glitches in the scheme which need immediate attention. First, the scheme is open for a very short period viz. November 5-20, 2015. Bank branches, even in metropolitan areas, are not fully geared to deal with investors. Secondly, the government has indicated a target of Rs 15,000 crore. It should be immediately clarified whether the figure of Rs 15,000 crore relates to this first SGBS issue or for the current financial year. In the absence of a clarification some cynical opinion makers can call the first issue a failure. Thirdly, like the Savings Bonds, and its previous avatar, the Relief Bonds, it takes time for the scheme to take off. An immediate measure could be to put the SGBS on Tap with a proviso that the government could close the scheme with a few days notice. Fourthly, for understandable reasons the scheme provides for a change in the price per gram on a weekly basis (for the first week the price is Rs 2684 per gram). This would, in the initial stages, create uncertainty for the investor.

Concluding Message

The GMS is meant for the big boys with large holdings of gold. The common person holding ornaments should just not participate in this scheme. The IGCS is again not meant for the common person. It is the SGBS which is tailor-made for small holders and it will take time for this scheme to take off. We need to recall that when the UTI was first launched, in the first year only Rs 6 crore were collected. The SGBS is a major development and it is necessary to nurse this scheme to its full potential which would bring about a reduction in the demand for physical gold.

Please Note: This article was first published in The Freepress Journal on November 16, 2015. Syndicated.

This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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