Though India’s gold demand has fallen off dramatically over the last two years thanks to the collapse in the price of gold in global markets, the imports are still substantial—FY15 imports were still $34.3 billion, though much lower than the $56.5 billion of imports in FY12 and $53.8 billion in FY13. The proposed gold bond scheme, put up for comments, looks like it could be a good alternative to those buying gold for investment purposes—of the country’s total demand of 843 tonnes in 2014, the investment demand was estimated at 180 tonnes or around $7.5 billion at today’s price of gold and exchange rate. If the scheme goes through in the current form, the government will give a 2% interest on gold bonds, so apart from the capital appreciation of gold, that’s a healthy return as well compared to nothing offered by physical gold—in the case of a 5-year bond, apart from the capital appreciation, a bond-holder will also earn an interest of 10.4%. Indeed, but for the possibility that those buying gold bonds may not like the KYC attached to it—while there is a KYC for buying physical gold as well, this is easier to circumvent—there is no reason why the scheme will not mop up the 50 tonnes the government seems to want to cap it at.
Right now, the scheme is supposed to be part of the government’s overall borrowing programme, but if the government wishes, it can expand the scheme’s scope to well above 50 tonnes. Under normal circumstances, anyone selling a gold bond should be hedging it by buying gold derivatives either on Indian or global commodity exchanges—in case the transactions take place on global exchanges, a currency hedge will also be called for. For now, the draft paper says the government may not hedge it since the hedge also costs money. But since the government is borrowing at 7.7% today and is offering to pay a 2% interest on the gold bonds, it has a cushion of 5.7% which it could use to buy hedges while not spending anything from its pocket—in any case, not hedging is not a wise policy. Indeed, if the government fully hedges the bonds, it can afford to not restrict the sales to 50 tonnes. The idea is a win-win since it protects the current account deficit while, at the same time, it doesn’t add too much to the government’s cost of borrowing.