Saturday, September 19, 2015

Gold Schemes Are Impractical And Unworkable.


The government has announced the Gold Bond and Gold Monetization schemes with great fanfare. The aim is to utilize the approximately 25000 Tonnes of gold in the country and channel them into financial savings or instruments so that annual gold imports of 800-1000 Tonnes come down. However, as is the case with most of the Government schemes, the actual rules, regulations, KYC requirements, capital gains, low rates of interest of 2.5% etc. are likely to make these schemes unworkable.

Buying gold has been a tradition in India not for decades but centuries. Wearing gold jewelry and gifting during marriages is a part of 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. The first is that these are being accumulated for future use as parents use their current cash flows to accumulate gold for their children’s marriages.
The second has been the investment buying which has been a result of the secular uptrend in the value of gold over the last decade where gold prices went up despite the crash in equities, real estate etc. till 3 years back after which gold has fallen or stagnated. The total value of gold at the current prices will be in a range of $ 800 billion to $ 1 Trillion.

Why the current scheme is unworkable:

  1. 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 run the risk of getting the infamous tax department after them.
  2. Secondly, 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 12-24% per annum depending on the place, need or vocation. As such this rate of interest is unlikely to attract anyone.
  3. As far as gold in the form of jewelry 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 RBI or the Government.Such monetization will be an absolute no starter.
  4. The only target segments that are likely to oblige the government could be some large temple trusts like Tirupati etc. A lot depends on how the large temple trusts respond.
  5. 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 again would be cash purchases & 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?
  6. I am not aware of the statistics, however it will be interesting to see how much capital gains the government actually gets out of purchase and sale of Gold. My view is that it will be negligible except for those holding ETF’s. As such, why would these people come out and invest in an instrument where Capital Gains tax is applicable.

The Government is not clear about what the purpose is. If the purpose is to lower imports, control CAD, get money into financial savings etc. then the route is different.

Why a gold amnesty scheme would work better:

There is a huge amount of gold which is there 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.
As such 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, the gold will be declared by the holders to the government and the government will, in turn, issue 10-year zero coupon bonds to the people who declare the gold. The yield on these bonds will be in the region of 3-4% and on redemption the amount that is paid will not be taxed in the hands of the holder. The post-tax yield on ordinary 10-year bonds are in the region of 6% and as such the 1-2% gap will take care of the tax that the declarer has not paid on the black money used to buy gold.
  • 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 INR to the government.
  • The other option will be for the RBI to sell this gold in the international market, realize the money in USD and provide the equivalent INR amount 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 the Foreign Exchange reserves, stabilize the rupee and build Foreign Exchange Reserves. 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 $ 40 million. As such 25 tons will be required for $ 1 billion. As such the government needs to target a quantity of 1000 tons 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 realize around Rest 2,50,000 Cr in 10-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. 

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