The new gold bond scheme to be launched is laudable as it is an attempt to wean away the public from investing in gold to other avenues. Intuitively, if households save their money in bonds rather than gold, then our import bill will benefit, which will keep our external balance in check.
The proposed gold bond scheme backed by the government will link the price of the bond with that of gold and offer an interest rate of 2% or more. When the bond is redeemed after, say, 5 or 7 years, the investor gets the current market value which is the rupee price of gold as of date. No one can invest more than 500 gm, which, say, at the price of R27,000 per 10 gm, will work out to R13.5 lakh approximately. The government, on its part, will issue bonds of the value of 50 tonnes to begin with, which would be R13,500 crore depending on the price of gold.
On the face of it, the scheme is good. The question is, whether or not it will work? The scheme does not require a person to surrender gold and exchange the same for a bond which earns this interest rate. Therefore, holding of gold and the bond are mutually exclusive. A person buying the bond could also be someone who would not be investing in gold and could enter the market for the first time. The bond will make sense for a person who likes a simple product. If we believe that, in 5 years, the price of gold will go up in the international market and that the rupee has to depreciate, then for a person with no interest in physical gold but in investment, this can be a good option. The rupee normally falls by 5% per annum and hence getting such appreciation makes sense. The hitch is, when one buys and sells gold, one can escape the tax net as all such transactions are through jewellers where there is no trail. Here one has to perforce pay capital gains tax.
The broader issue for the investing public is, whether or not this will make sense? Today, gold ETFs have not quite picked up. The futures market is buoyant but caters to an investor community which is agnostic towards any product as long as there is volatility, as they have no desire of holding the product. If knowledge of commodity was equal across all spectrums, they would be prepared to trade in guar seed as much as gold. No physical transfers take place. This being the case, investors may be a bit distant from a product which requires going to a bank or a post office to purchase them, leaving an audit trail.
Now, can such a bond migrate a holder of gold to the bond by bringing in substitution? In India, if 300 tonnes gets imported every year, it is more for holding on to the metal for sake of pride or tradition. There is a belief that such an ownership enhances one’s importance in the social order. If we get these people to break away from this statute, the scheme will be successful. Therefore, the government has to hold awareness programmes to convince the folks that this product is akin to holding gold with advantages of security. Leaving it to post offices or banks to market is not possible as the former are generally not interested and banks have their own products to market. Therefore, unless this can be done, there will be little migration.
Further, the bond will be listed and cannot be redeemed before the date at the bank. Asking him to go to a commodity exchange to trade is expecting too much, as this involves further cost and inconvenience. Hence, it remains to be seen if such a scheme really takes off or gets in investors who are not the ‘gold buyers’.
The government being the issuer will bear the cost of hedging. This is interesting because the transaction would be between the buyer and the government, with the government paying the final cost which will almost definitely be higher. If the price of the bond is lower, then most definitely the household will feel that it has been cheated, which never happens when physical gold is dealt with as, practically speaking, such gold never has a maturity date. Therefore, to keep the scheme attractive, the government has to hope that the price of gold does not come down. But for prudence, the government should be hedging the same on the NCDEX, which is the exchange whose quotes are being used; and probably the exchange risk too. If the amount to be hedged is R13,500 crore per year, with a possibility of 5% rupee depreciation, 2% interest and another 4-5% gold appreciation cost, the hit could be high. Otherwise, the cost, at around 10%, would be higher than the normal cost of 7.5-8%.
Another issue is exclusion. Would this be a scheme only for households or can institutions also come in. While institutions like mutual funds would find a limit of 50 gm too small, companies may like to invest in such bonds. Households, too, may be hesitant to reveal themselves as potential gold-holders for identification. As there is no transfer of gold, temples will be out of this scheme. Last, the government will have a problem marketing them as they will be clashing with their own tax-free bonds which will be out this year—these carry good returns with tax benefits. Therefore, such bonds may be a slow starter.
The government has taken the trouble of looking at various options to control gold consumption. A tax on gold is definitely more efficient and the ideal way to lower demand to an extent. Expecting households or trusts to part with gold for ‘saner’ deposits has not worked in the past to actually lower demand. The gold bond is a monetary transaction which involves no holding of gold by either the government or the buyer. If it meets with success, we can stretch to creating products that take gold from the holder of the metal. Otherwise, we can say that we have at least tried.
The author is chief economist, CARE Ratings. Views are personal