Lack of this, and the KYC, could trip it up
Given that gold imports in FY15, at $34.4 billion, were roughly 1.7% of GDP—though sharply down from the $53.8 billion of FY13—it is not surprising that the government is keen to find a way to minimise the impact of this on the current account deficit (CAD). Gold bonds were the obvious solution, and after the government came out with a draft policy in June, RBI announced details of the gold monetisation scheme last week. There are, then, two schemes at work. In one, people take their physical stocks to a bank and get an interest on this for short-term and long-term schemes. The scheme is available for both jewellery as well as biscuits/bars—the former is unlikely to be given to banks given the loss in making/breaking charges, but the amount of investment gold is also quite high since, of the total 843 tonnes of demand in 2014, 180 tonnes was in the form of coins/biscuits/bars.
The second part of the scheme involves non-physical gold, but the details of that are yet to be announced. The way the scheme is to work, if a person wants to buy R1 lakh of gold, he goes to a bank and gets a piece of paper acknowledging the bank/government owes him 37 grams of gold; an interest is paid on this and, at the time of maturity, the individual gets back the gold (plus the interest that accrues of this) either in physical form or as cash—obviously the preferred mode, from the government’s point of view, is cash. Had the scheme not been in place, physical gold would have been bought and since it would have been imported, the CAD would be under pressure. In this scheme, however, no physical gold is bought, so there is no pressure on the CAD—the bank, however, buys a hedge, so that it does not lose in case the value of the gold appreciates and people have to be paid back a higher value. Since the government is borrowing at around 7.49% today, theoretically, the government can afford to pay a reasonable rate of interest on this even after paying for the cost of buying a hedge to account for the possibility of gold values appreciating over a period of time.
Both schemes are desirable since people will get some returns on their gold—in the non-physical gold bond, there is an added advantage since the country doesn’t import gold either. There are some issues, however, that still need clearing up. KYC will be one and, while it is true there are KYC requirements even for buying physical gold, these are relatively less stringent. The bigger problem will be of the lack of liquidity. Right now, RBI is talking of short-term deposits of 1-3 years and longer-term deposits of 5-7 or 12-15 years. Theoretically, this gives investors a large range to choose from. But the key to all investments is liquidity, and that is something that goes away once an investor is locked into any tenure. Ideally, the scheme has to be fully liquid—otherwise, the loss on capital value in a down-cycle can be far greater than the interest earned; the existence of premature withdrawal penalties only makes the equation less attractive.