IN my last week's write-up, I had broadly touched upon the role of gold in India, and introduced the Gold Deposit Scheme. This week, I will broadly analyze the scheme, from the point of view of various participants in this scheme:
I Investor's Point of view: Major advantages of this scheme to the gold depositor would be:
a) there is no need for the depositor to hold gold in physical form, so he is relieved of security related problems;
b) depositor would continue to earn capital appreciation.
c) He can take advantage of the various tax incentives. Various provisions have been made in the income tax laws as incentive to the gold depositors, which are:
i Capital asset [Sec.2(14)]: A clause has been inserted in this section to provide that Gold Deposit Bonds would not be treated as a capital asset and therefore, would not be subject to Capital Gains Tax on their transfer.
ii Interest on Gold Deposit Bonds [Sec.10(15)(iv)]: It has been provided that interest earned on the bonds would be exempt from tax.
iii Wealth Tax Act [Sec.2(EA)-Expln.2]: It has been provided to exempt these bonds from Wealth Tax by clarifying that jewelry which is subject to Wealth Tax will not include Gold Deposit Bonds.
However, there are some reservations for the success of such a scheme: a) Large gold holdings being a store of unaccounted wealth, gold mobilization efforts would not succeed unless an amnesty scheme is appended as a lure.b) The scheme may not be successful in India given the Indian's aversion to parting with the "family treasures".
c) It may also be pertinent to add that the Gold Control regime which prohibited storing of gold bars, has led to gold being stored largely as jewelry, which the owner would ordinarily be reluctant to convert into standard bars for placement as deposits.
d) Gold in the jewelry form, may not in the purest form. Before the gold is deposited, the same is assayed to check it's purity. A lot of gold is not in the purest form, though the owner may believe so. He may go to the bank expecting that his gold is 22k and may find out from the bank that it is 18k. He may not be in the mood to deposit more gold for lesser interest.II Gold Fabricator's point of view:
a) A major problem faced in the local market and by exporters is the price risk. When a jeweler buys gold at today's price, he adds value to it and makes jewelry. May be four weeks later when the jewelry is ready for sale (the typical terms of trade at the time of sale are the gold price plus making charges, and the applicable gold price is the current gold price, whereas he had bought the material four weeks ago) the price of gold is different and thus creates a price risk which the jeweler does not want.
The solution in such cases is perhaps gold loans. This is where a commercial bank who would be a participant in the scheme can play a crucial role. Given that the gold interest rates are traditionally much lower than the currency interest rates, jewelers input cost would be considerably lower.
Again as the repayments have to be made in gold , which the jewelers would purchase on the repayment date at the same rate at which he is selling his jewelry, he would be insulated from the price risk he would otherwise have been exposed to.
But, MMTC already plays this role to a greater extent and at a lower rate of interest to the exporter community. Banks could fill in the gap for the local jewelers.
Commercial Bank's point of view:
a) For the banks this would be one more product in their stable and RBI's incentive in this scheme would be to monetise the idle gold into the real economy needs. Banks offer gold-denominated bonds/deposits and loans carrying a nominal rate of return. The settlements of these deposits is done in rupee terms only.
b) Banks should be able to deploy the gold so mobilized by way of gold denominated loans to the industry or swap them for rupees for lending or investing. This would mean an alternative source of funding for them. When lending these resources in either rupees or foreign currency, banks expose themselves to the risk of gold price fluctuations.
Banks would therefore be an important player in the gold derivatives market. There is also the need of instituting effective risk management systems in banks for gold and gold related products on the lines of currency/interest rate risk management. Gold loans would be made to gold as working capital for their jewelry business.
Another initiative that probably banks could look at it is spot bullion trading. What banks could do is to take a little bit of a price risk and trade intra-day at least so that they would sell to the customer and then hedge themselves or cover themselves during the day sometime. This is, of course, subject to RBI's blessings and approvals.
(The author is a Fund Manager & Consultant with an Indian Financial Institution. The opinions expressed, do not, in anyway, reflect the corporation's views, and are solely that of the author. This is not intended as an offer or solicitation to buy or sell, or methods to trade. For any queries, the author can be reached at aghiya@vsnl.co)
Copyright © 2000 Indian Express Newspapers (Bombay) Ltd.