The new Gold Monetisation Scheme – V.P.Nandakumar

The new Gold Monetisation Scheme – V.P.Nandakumar

On May 21, the Central government released the draft guidelines of its much awaited gold monetisation scheme. That the scheme was in the pipeline was first revealed in this year’s budget presented by the Finance Minister in February. Three months later, the draft version has been put out for discussion and feedback.

Efforts to monetise the gold stock in India have been going on for decades. It all began way back in November 1962 with an issue of 15-year Gold Bonds offering 6.5 percent interest. In 1965, a new series of 15-year bonds was launched that was redeemable at maturity in gold of standard purity. A Gold Bond scheme was launched between in 1993 which allowed subscribers tendering a minimum of 500 grams to buy 5-year gold bonds with a fixed lump sum interest payable on maturity. In 1999, it gave way to the Gold Deposit scheme (GDS). State Bank of India launched its GDS in November 1999 and then discontinued it, only to re-introduce it in 2009. The design of the GDS is quite similar to what is proposed in the current gold monetisation scheme. With interest rates left to the discretion of the banks, SBI initially offered between 1.0 percent to 1.5 percent for deposits of 3 -5 years. This was reduced, in 2010, to between 0.75 percent to 1.0 percent. No surprise then that response was poor and State Bank could only mobilise 15 tonnes or so.

The difference now

The new gold monetisation scheme (GMS) is strikingly different from its predecessor (GDS) in one crucial respect; it reduces the minimum quantity of subscription to 30 grams from 500 grams earlier. The lower threshold for entry will certainly encourage greater retail participation.

Another noteworthy difference, whose import has not been fully recognized by analysts, is the proposal to make payment of interest valued in gold.  In GDS, interest is low and paid out in rupee. In the new scheme, the rate of interest is not specified and has been left to the banks. Presumably, there will be some incentives for banks to offer a better rate than before.  Besides, it is important to recognise that to people for whom gold is a de facto currency, interest payments valued in gold delivers gains that are real and inflation-proof. The depositor is always assured of a positive real rate of return. In contrast, the earlier scheme offered low rates of interest that, moreover, was paid out in currency subject to debasement. It is also in marked contrast to ordinary bank deposits where real returns adjusted for inflation have often been negative in the recent inflation ridden times.

To truly appreciate how interest paid in gold would make a difference, consider the following example. Imagine you own an acre of land and someone offers to rent it from you for a period of one year. In return, he promises to add one extra cent of land so that you get back 1.01 acres at the end of one year. Who will not jump at the offer? The fact is, when we invest in real assets, the only expectation we have is of appreciation in the value of the land, not in the size of the plot. Any return over and above is a welcome bonus.  If 100 grams of gold become 101 grams at the end of one year, the extra gram of gold is a windfall.

I mentioned earlier that for many Indians, gold is like a currency. Cultural factors play a large part in driving the demand for gold in India. Many transactions of a socio-cultural nature have gold as the medium of settlement. A common example is a wedding where relatives gift the couple with gold defined in terms of its weight (never in terms of the rupee equivalent). The prospect of appreciation in the physical stock of gold, together with the original promise of appreciation in value, would make it a compelling proposition.

Does it go far enough?

Barring these two points, the new monetisation scheme is not very different from the earlier gold deposit scheme. Indeed, from a reading of the draft guidelines, it would seem that the scheme does not offer sufficient incentives to the banks to promote the scheme aggressively. Moreover, since the procedures outlined involve significant coordination between banks, customers, collection/ purity testing centres, refiners and jewellers, it is likely that the actual implementation will involve hassles, and may even be fraught with risk.

Besides, as the current proposal is to use only 350 BIS certified hallmarking centres across India as purity testing centres, the scheme will have limited reach in the initial years. Further, no role is envisaged for the gold loan NBFCs. The availability of gold appraisal skills at their extensive branch network could have been leveraged to extend the reach of the scheme into rural and semi-urban areas. For now, the government has chosen to pass up the opportunity. One hopes the door will be kept open. Lastly, the scheme envisages each depositor individually doing the rounds of the assaying centre and banks. Gold loan NBFCs can be considered in the role of “aggregators”, offering a one stop service centre to make the experience hassle-free.

Notwithstanding these limitations, the new Gold Monetisation Scheme is a step in the right direction. It is perhaps better seen as a promising start rather than an end in itself. Importantly, it signals the resolve of the government to come to grips with an intractable problem.

V.P. Nandakumar

(V.P. Nandakumar is MD & CEO of Manappuram Finance Ltd. Views are personal.)