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Getting the paper gold equation right PDF Print E-mail
Saturday, 29 July 2017 00:00
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Saikat edit

On-tap gold bonds is a good idea but pricing must also be real-time and scrap the lock-in

Apart from the Indian affinity for gold, given how demand rises in times of uncertainty or high inflation, it is not surprising that gold demand has been as high as it is. In 2010, for instance, demand crossed 1,000 tonnes. It was only as India’s macros started looking better that demand fell, to below 900 tonnes in 2014 and to a reasonable 667 tonnes in 2016—the combination of demonetisation and the fear that GST rates on gold could be high, however, ensured that India imported $21 billion of gold in the first half of 2017 compared to $23 billion in all of 2016. Since gold demand is mostly met through imports, years of high imports are ones of high current account deficits which, in turn, have weakened the rupee. So, in FY12, when India imported $56.5 billion of gold, the current account deficit increased to $78.2 billion, a whopping 4.3% of GDP; it peaked at $88.2 billion or 4.8% of GDP in FY13, when India imported gold worth $53.8 billion.

It is to reduce this huge import bill that, in November 2015, the government tried to introduce gold bonds—if investors bought gold bonds, and these were hedged by buying futures in global commodity markets, the argument was, the country would save on precious forex; as for the investors, they would still benefit from the security provided by gold prices; as it happened, since RBI took on the volatility risk, the gold bonds were not even hedged by trades in global markets. Since, on average, investment demand for gold—calculated as the demand for bars and coins—is around 30% of total consumption, the government hoped it would be able to substitute a large portion of this. In order to make the scheme attractive, an interest rate of 2.75% was also given on the first five tranches of Sovereign Gold Bonds—this was lowered to 2.5% for the subsequent ones. In the first six tranches for which data is available, however, just 14 tonnes of gold has been substituted—that’s 2% of the average gold consumption over the past five years or less than 6% of the average investment demand.

This is because of the bad design of the product which did not take into account the reason people bought gold, apart from the anonymity. The bonds were bought/sold on the basis of the average price five days before the transaction—this ensured buyers/sellers lost out on the appreciation of gold—and on days fixed by the government. Similarly, there was a 5-year lock-in for the bond—a real killer, given people buy gold for its liquidity. Some of this is sought to be fixed by now planning to offer the bonds on tap—while this will allow investors to buy gold when they want, the 5-day average price for the transaction simply has to be done away with. Similarly, while there is a plan to bring in market-makers to ensure greater liquidity for the bonds—they are listed on exchanges—it does not make sense to have a lock-in for the bonds; a more liquid market will ensure the bonds can be sold, but the lock-in will mean the price got for a sale will be discounted. At the end of the day, the government has to decide if it wants the scheme to succeed or not—if it does, it has to ensure it offers the same advantages that gold does; without that, it won’t take off.

 

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