Deconstructing the yellow metalís sheen

Nov 28 2012, 01:59 IST
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SummaryIn order to reduce the quantum of physical holdings in the country, the deputy governor of the Reserve Bank of India, Subir Gokarn, has proposed the idea of holding the metal in demat format like any other financial product.

With soaring gold imports and a widening current account deficit, RBI is now pushing for the launch of gold-backed instruments to discourage physical investment in gold. Hereís how such a move might affect gold demand, supply and prices

Why does RBI want gold holding in demat form?

In order to reduce the quantum of physical holdings in the country, the deputy governor of the Reserve Bank of India, Subir Gokarn, has proposed the idea of holding the metal in demat format like any other financial product. At the recently-held annual Bancon in Pune, the deputy governor said that the central bank is considering alternative channels for investment like a modified gold-backed scheme, gold-linked accounts, gold accumulation plans and gold pension plans. These schemes, if implemented, would discourage physical investment in gold. He also said that a working group headed by KUB Rao of RBI will shortly be coming out with its report on the ways to deal with the problem arising from high gold imports on the balance of payments.

How would RBIís proposed gold-backed instruments work?

Though the details of the gold-backed instruments will come out in the RBI report, according to Subir Gokarn, the gold accumulation plan will be similar to the systematic investment plans of mutual funds, in which the plan will buy a small quantity of gold at regular interval without any physical delivery. The gold-linked accounts could be non-interest bearing accounts, where the gold would be purchased and hedged abroad and give an account holder exposure to the global gold market without any physical delivery. Similarly, the gold pension plan would be similar to the reverse mortgage scheme of properties that banks offer.

Why is the current account deficit rising?

Rising gold imports have pushed up the current account deficit to a historic high of $72 billion or 4.2% of GDP in 2011-12. Of that, gold accounted for 70% of the current account deficit. For 2012-13, the Economic Advisory Council to the Prime Minister had projected the current account deficit at $67.1 billion, or 3.6% of the GDP and that can be achieved if gold imports are reduced. To curb the import of gold, the government last year had increased the import duty of the metal. The import duty on gold has been fixed at 2% of the value instead of the earlier R300 per 10 grams.

Why is gold demand rising in India?

India is the largest importer of gold in the world. In 2011, World Gold Council data shows, the demand for gold increased to 961 tonnes valued at $47.8 billion dollars. In the nine months to September this year, India has imported 591 tonnes of the precious metal valued at $32.5 billion. Demand had slowed down in the three months to June this year to 181 tonnes because of high prices, and a nation-wide strike among jewellers in protest of government plans to increase the excise duty on refined gold from 1.5% to 3%. However, after much pressure, the government rolled back the the proposed hike before the auspicious Akshaya Tritiya festival. The demand of the metal, however, picked up in the three months to September this year to 205 tonnes because of festival and marriage buying. Moreover, according to the World Gold Council, although lower monsoon rains during August had curtailed demand, a recovery in rainfall during September boosted sentiments and drove the relief-related demand. With the price of gold almost doubling in the last two years, the metal has given the best 5-year returns as compared with bank deposits and the Sensex. Traditionally, like everyone globally, Indians too consider gold as a good hedge against inflation and with headline inflation remaining sticky, the demand for the metal has risen.

How do Indians invest in gold?

In the physical form, jewellery accounts for about 60% of the total demand and the rest is in the form of bar and coins, basically for investment purposes. Increasingly, Indians are also investing in gold ETFs with mutual funds because, by investing in the paper form, one can eliminate issues related to purity, insurance, storage and even reselling. The assets under management of mutual funds went up from R743 crore in March 2009 to R11,477 crore in October 2012. One can invest in the yellow metal through the mutual fund route or gold systematic investment plans. It enables the investor to invest in the yellow metal in paper form. One can also invest in e-gold through the National Spot Exchange. With a demat account, one can buy gold in units as small as one gram from the exchange where you have to open a demat account and this can be converted into coins and bars. Gold purchased from the spot exchange is cheaper than buying from banks and the exchange also follows a certification process similar to banks. Like equities, the settlement of e-bullion units follows a T+2 cycle.

What are the other steps RBI has taken to curb the demand for gold?

In April this year, the central bank brought down the loan to value or LTV that gold loan companies like Muthoot Finance or Manappuram Finance could offer to just 60% of the market value, from a high of 85-90%. This was done to reduce the rising demand for gold loans as the central bank fears that if the price of gold falls, the non-banking finance companies, which form the bulk of the gold loans, will suffer. Also, last week RBI banned banks from giving advances to dealers for purchase of gold, gold bullion, gold jewellery, gold coins and even units of gold exchange traded funds. However, it allowed banks to provide finance for genuine working capital requirements of jewellers.

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