Gold monetisation scheme: Will it triumph over other similar products?
Wed, 04 Nov 2015 18:49:40 -0700
Gold sovereign bonds are easy to implement relative to the gold monetisation scheme
TAGS: COMMODITIES, GOLD MONETISATION, SOVEREIGH GOLD BOND, SAVINGS
The sovereign gold bond scheme is an attractive product and may address the pure investment demand for gold. Gold sovereign bonds may triumph over other comparable products in the market such as gold exchange traded funds and physical bars, and can lead to a reduction in India’s current account deficit. Also, gold sovereign bonds are easy to implement relative to the gold monetisation scheme.

A successful launch of this product may ensure that physical gold is used mostly for manufacturing jewellery and sovereign gold bond for investments. Investors of gold bars or coins may find gold sovereign bonds a better investment than holding a physical stock because it will offer the benefit of gold without any handling and storage costs.

It will relieve investors of the need to check the quality of gold and with valuation, no longer an issue, these bonds will be easier to use as collateral. In case of a gold bond, the counterparty is the government of India. If the price of gold increases, the government takes the risk of higher prices, if they fall, the investor would be given an option to roll over their holdings for an additional period.

The cons of the scheme are that the sovereign gold bonds are beneficial only if it is bought for investment purposes. The government has not yet set the interest rate on this scheme. As the bonds will be issued in denominations of 2g, 5g, 10g of gold, a minimum investment required would in the range of Rs 5,000 and above.

This means small investors will not be able to take advantage of this scheme unlike the case with gold exchange traded funds or gold mutual funds. In case of sovereign gold bonds, both upside gains and downside risks will be with the investor.

However, in case gold prices fall, losses from a systematic investment plan in gold exchange traded funds or gold mutual funds will be lower than for lump sum investments in sovereign gold bonds.

The gold monetisation scheme is also a welcome step taken by the government to unlock the value of gold held by households/institutions and to reduce the dependence of Indian investors/ gems and jewellery sector on imported gold. Also, it is an improvement over the existing gold deposit scheme 1999.

As for the pros, the scheme offers all the benefits of physical gold minus the risk. It will convert the unproductive asset (lying idle) into a productive asset (used by the gems and jewellery sector). It will help in reducing the black economy, as gold along with real estate is often used as safe haven to park black money.

The reduction in intermediary including speculators may be positive for stabilising gold prices.

If the gold monetisation scheme turns out to be successful, then it will lead to a spurt in the supply of gold leading to a decline in gold prices, as the recycling of domestic gold will be without any import duty. Banks have some incentives in this scheme, like the freedom to decide interest rates on gold deposit and the ability to sell gold to raise foreign currency, it can also be part of statutory ratios. It will thus have a positive impact on the current account deficit.

On the other hand, the scheme envisages holding gold only in its pure form, resulting in the melting of the deposited jewellery and ascertaining its pure gold value. This will be a disincentive for a large number of households who generally want to keep gold in the form of jewellery and may not want to see their long-preserved, family-inherited, emotionally attached, piece of gold lose its identity and feel, for meagre returns.

Also, the jewellery making charges paid at the time of buying it will be lost in the process. Moreover, ascertaining of pure gold out of the jewellery will often result in lower valuation of the gold held by households.

First, the loss of jewellery making charges and secondly lower valuation together will be a double whammy for households. There is also lack of clarity on the tax treatment, on the conversion of physical gold into the gold deposit scheme.
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