The Budget has announced various schemes which can be termed as game-changers—the monetisation of existing stocks of gold is one such. It also talks about two products—the New Gold Deposit Scheme and Sovereign Gold Bond Scheme.
The announcements owe their origins to the KUB Rao committee report whose message was: “Given the complexities involved in the lure for gold in India, a holistic strategy that deploys a combination of demand reduction measures, supply management measures and measures to increase monetisation of idle gold stocks needs to be put in place.” An SBI study also arrived at similar conclusions but with certain riders.
Investment versus hedging: Is the demand for gold an investment demand or a hedging demand? Given the store of value function of gold and the behavioural pattern of the Indian consumer who never trades gold but buys it as tradition for social security, it is the demand for hedging and wealth preservation which is central to gold demand. The popular phraseology always terms the demand for gold as ‘investment’, thus confounding the issue.
Choice of gold fix: Monetisation of gold can be facilitated in two ways. One, by extending gold loans. Two, by designing products (deposits, gold bonds) where gold currency earns gold rate of interest. Monetisation will require a gold fix rate that allows seamless conversation of gold to fiat currency. In case of loans, gold fix determines the loan-to-value ratio, whereas in the case of the latter, it decides the quantum of interest payments. In the monetisation schemes in the Budget, which fall in the second category, the choice of gold fix used to calculate returns is important. For existing gold deposits, interest is calculated using the London AM rate of gold currency (XAU) and paid in equivalent rupees.
But this benchmark has been under scrutiny since May 23, 2014, when the financial services register of the Bank of England imposed a penalty of £26,033,500 on a bank for failing to manage conflicts of interest. The US Commodity Futures Trading Commission and the US Department of Justice are also investigating institutions in their collusive behaviour in gold fixing impacting the price discovery. The Intercontinental Exchange Benchmark Administration will run an electronic gold price benchmark from March 20 to replace the century-old London fix. China is planning to launch a yuan-denominated gold fix which can be complementary to the dollar gold-fixing in London in 2015. The contract for the Chinese fix would be traded for a few minutes each day to make the process transparent, addressing one of the biggest complaints about the London fix. In the interest of customer protection and manipulation, steps are needed to develop an equivalent domestic benchmark in the medium term. On a serious note, why should India not leverage on its monopsony power in the global gold market and launch an Indian gold fix?
Onshore and offshore price of gold: Another problem with monetisation is that while gold products mimic the returns on gold using the price of gold in global markets, there exists substantial difference between the onshore and offshore price of gold. It can be as high as R10,660 per 10 gm on an average over the last 15 years. It creates a wedge between actual returns and perceived returns on gold products in the minds of the investor who is not allowed to buy gold in the global market. This is the biggest challenge.
So what should be the structure of the new scheme?
(a) Mobilisation should happen only for gold bars and coins, since jewellery carries sentimental value.
(b) Any gold deposit taken from the public must be redeemed in gold itself as a default. There should be a legal promise to instil confidence in the public. The government may redeem in gold coins. There could be an alternate option to reward in rupee terms where principal will be paid in equivalent rupee value of gold as on date of maturity and interest is calculated in an equivalent domestic benchmark and paid in equivalent rupee.
(c) There are some proposals on the use of gold mobilised by banks. One, the use of gold in MGL which is already in force but will require modifications. Two, the use of mobilised gold as SLR security (in force). Three, the use of gold in maintenance of CRR with RBI (Turkey has a scheme like this). Four, the outright sale of gold by banks to RBI (for creation of strategic gold buffer with RBI) so that the amount of forex reserves lost in purchase is substituted by gold.
(d) The last two proposals must be seen in context of RBI monetary policy. RBI may accommodate both these proposals by specifying two ratios (like it specifies CRR and SLR). The first is the amount of gold deposits that RBI will purchase from the banking system depending on its assessment of strategic reserves. The second is the amount a bank can keep in CRR in the form of gold.
We welcome the gold monetisation measures and these could be a game-changer if properly designed. It is essential that customer protection is central to designing and marketing of such a scheme as ultimately it is the trust that drives the popularity of a financial product.
(Saket Hishikar contributed to this article)
By Soumya Kanti Ghosh
The author is chief economic advisor, SBI. Views are personal