Gold monetization scheme: Why offering higher rate of interest is critical for its success

Mumbai: The crux of the suggestions received by the government from public on the proposed Gold Monetization Scheme (draft guidelines of which were released on 19 May and feed backs sought till 2 June) somewhat sums up the mentality of average Indian households on gold.

No one wants to see his long-preserved, family-inherited, emotionally-critical, piece of yellow metal lose its identity and ‘feel’ by melting it. Two, nobody seems to be happy with the lower rate of interest being talked about (about 1 percent to 2 percent) and, finally, no one is particularly keen to produce any sort of invoices that confirms his ownership of the yellow metal.

These suggestions rightly mirror the mentality of Indian households, for whom gold is much more than an avenue for investment. The government has been trying out all methods to cut down the gold consumption in India. It has employed different methods–sharply hiking import duties and prodding public return the idle stock of gold lying in domestic households and temples back to circulation.

The government hopes to bring down the import of fresh stock that significantly adds to the current account deficit. India’s gold demand was estimated to be around 840 tonnes in 2014, half of which was probably used for wedding purposes. In this backdrop, getting the dormant gold stock (estimated about 20,000 tonnes) back to the system is critical. GMS is part of the plan.

Going by the draft, under the GMS, an individual or entity can walk into a test centre and gets the gold melted, purity assessed and converted into bars, against which the bank will issue a certificate to the holder. On this deposit, the customer earns an interest decided by the bank, which will be exempted from income, wealth or capital gains taxes. On maturity, the customer can get the gold or cash back plus interest amount.

This is pretty much same as the gold deposit scheme that has been in existence for long. The key difference between the two is the minimum quantity of gold that can be monetized. This has been brought down to 30 grams in the proposed GMS as compared with 500 grams under the existing gold deposit scheme. Hence, this time, the government seems to target HNIs and households rather than temples and trusts.

Also, banks can use this gold to calculate their mandatory reserve requirements such as cash reserve ratio (CRR), currently 4 percent, and statutory liquidity ratio (SLR), 21.5 percent. The scheme can work only if the government listens to the critical feedback received on critical areas mentioned above. Firstly, it will be a foolish thought to expect that someone will come to deposit the gold for a meager return of one percent as in the old scheme—one of the reasons why it miserably failed. The smarter thinking is to offer a higher rate of rate of interest to the depositor calculated on the rupee value of the gold based on the prevailing prices. Something in the range of 7 percent to 8 percent can possibly work.

This rate can be revised periodically on the basis of the prevailing gold prices. For someone with excess gold and willingness to deposit it for investment, this is an equally attractive option just a bank fixed deposit (still, a one year bank FD yields up to 8-8.5 percent). Second, the government can offer a choice to the customer with respect to the melting of the ornament. A differential rate of interest can be offered on melted and non-melted gold. This can be done still not compromising on the purity assessment. Someone who isn’t willing to melt his ornaments will have to settle with a lower rate of return.

Such a provision can make a big difference if government pays attention to the mentality of an average Indian. Like mentioned above, Indians see gold not as a mere investment but more as a symbol of their status.

In most Indian households, especially in southern states, gold ornaments are passed on from generations to generations as a family asset, closer to their heart. Parting with gold, by selling or pledging, is perceived as a social ignominy. It is a desperate step taken by an average Indian household in cases of extreme distress.

Hence, it would be unwise to expect households to actively participate in any schemes that involve ‘melting’ the long-preserved jewelry. The past record of the gold deposit schemes that have so far received lukewarm response is a proof for this. The option to the customer on this part can encourage him to participate in the scheme.

Dealing with the ownership of the gold is a rather tricky part. It is unlikely that any household, where gold is a family-inherited property, can produce any documents that prove their ownership. But at the same time, as Firstpost noted before , fully exempting ownership proof, can give an easy route to unaccounted gold-holders to earn legitimate income on smuggled gold.

The government can partly address the problem to a certain extent by making invoices mandatory only for gold brought in the form of bars or coins and not necessarily for household ornaments. The banks can track the transaction with sufficient proofs on address and identity. In case, the quantity exceeds a particular limit, even on ornaments, questions can be raised.

Unless the government structures the GMS carefully, the fate of the scheme cannot be far different from that of its older version.