Investors would lose money in gold bonds if the govt cuts import duty from current 10%

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New Delhi | Updated: Nov 05, 2015 9:48 PM

PM Narendra Modi on Thursday launched two schemes on gold (Gold Monetisation Scheme, Sovereign Gold Bonds Scheme) as well as a sovereign gold coin, as the government aimed to broaden the investment choices for individuals as well as households, and also discourage imports of the precious metal.

 gold monetisation schemeIn case of the gold monetisation scheme, while banks want the facility to pledge more gold and less cash with Reserve Bank of India against their reserves requirements so that they can use the excess cash to lend at attractive interest rates, the central bank hasn’t granted any such concession to them. (PTI)

Prime Minister Narendra Modi on Thursday launched two schemes on gold (Gold Monetisation Scheme, Sovereign Gold Bonds Scheme) as well as a sovereign gold coin, as the government aimed to broaden the investment choices for individuals as well as households, and also discourage imports of the precious metal. Although Modi has described the schemes on gold monetisation and sovereign gold bond as an example of “sone pe suhaaga” (icing on the cake), analysts believe these may not achieve runaway success instantly, despite having potential to establish the precious metal as a viable investment instrument, as certain issues have not been adequately addressed.

Still, the monetisation scheme may gather some 20-25 tonnes of gold in the next six months, as the minimum deposit limit has been brought down to just 30 grams and depositors will get up to a 2.5% interest annually, said analysts. This will be a huge improvement upon the old monetisation scheme, launched in 1999, under which only about 20 tonnes of gold was mobilised so far, as the interest rates were less than 1% and the minimum threshold of deposit was as high as 500 grams. Even SBI’s gold scheme could manage to garner only about 8 tonnes despite the existence over the years. Under the bond scheme, apart from a 2.75% annual interest, the investors can potentially gain from an appreciation of gold price under the bond scheme.

However, the biggest risk for potential investors is that the public issue price of Rs 2,684 per gram for the sovereign gold bond, which was based on the average gold rate in the domestic market in the previous week, includes a 10% import duty on the precious metal. So investors will lose money should the government cut the basic customs duty on gold at any point of time before the maturity of the bonds, as domestic prices of the precious metal would then drop accordingly. And as the bonds will be for a period of eight years with exit option from only the fifth year, there is a real chance that the import duty may be trimmed in between.

Moreover, unlike the easier entry and exit options–as in the case of, say, a gold exchange-traded fund–some investors may find the option of exiting the sovereign gold bonds only after the fifth year unattractive. It’s not yet clear if the bonds will be traded on exchanges so that an investor can have the option of exiting whenever he wants to, said Kishore Narne, head of commodity and currency at Motilal Oswal Commodities. “It would have been better had the government settled all these issues before launching the schemes,” he added.

The fact that investors will have to pay capital gains tax on the bonds will also reduce its appeal, as while selling physical gold, people practically don’t pay any tax, even though there are express provisions for such a tax in law. So while the government seeks to sell the bond as an alternative to the purchase of physical gold, in effect, this is not so.

While the monetisaiton scheme aims to tap household gold stocks of over 20,000 tonnes worth over Rs 52 lakh crore, through the bond scheme, the govenrment wants to shift part of the estimated 300 tonnes of physical gold bars and coins purchased every year for investment into the ‘demat’ gold bonds so that the impact of huge imports on trade balance can be contained. The sovereign gold coins, adorned with Ashok Chakra and the Gandhi image, will be available in denominations of 5 and 10 grams initially. All these schemes were announced by finance minister Arun Jaitley in the last Budget.

In case of the gold monetisation scheme, while banks want the facility to pledge more gold and less cash with Reserve Bank of India against their reserves requirements so that they can use the excess cash to lend at attractive interest rates, the central bank hasn’t granted any such concession to them. Soumya Kanti Ghosh, chief economic advisor with SBI, said banks may not find themselves adequately incentivised to promote the scheme in a vigourous manner in the absence of any relaxation in the cash reserve ratio norms, considering that they have to include other costs while calculating their returns.

Moreover, the apprehension that taxmen may hound depositors coming to park unaccounted-for gold in banks may also put off some investors. Already the government has made it clear that it doesn’t want the scheme to be used as a tool to convert black money, stashed in the form of gold, into legitimate investments. Even stocks for decades with temple trusts or households have huge antique or sentimental value, and since the scheme requires the precious metal to be melted, not much of such gold is expected to come out for deposits.

Rajiv Popley, director at Mumbai-headquartered Popley Group, said the scheme would improve the availability of gold in the country. “If the banks get more gold in deposits from people, they would also lend more to jewellers. Moreover, banks would gain in the sense they don’t have to hedge the precious metal and incur costs,” he said.

Asking policy-makers to temper expectations from these schemes initially, Somasundaram PR, managing director (India) at the World Gold Council said they will, nevertheless, bring a range of collateral benefits to the industry by significantly raising infrastructure standards. “No one scheme or single way of buying gold is a total replacement of the other. Together, these options, expand consumer choices.”

Under the monetisation scheme, banks will take gold from people for deposits up to 15 years and auction them off or lend to jewellers from time to time.

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