Given the Indian obsession with gold as well as the fact that, in times of uncertainty, it is the best hedge against inflation and poor growth prospects, it is just as well that the government has come out with a gold bond as well as a gold monetization scheme. Though demand today is amongst the lowest it has been in the last few years, it still added up to 346 tonnes or $13.4 in January-June 2015 – that is a big drain on India’s forex reserves especially at a time when export earnings are so poor, and it also represents savings that could have gone into the financial sector and which, therefore, would have been available to lend to potential investors. While not all the demand will convert to gold bonds, at least part of the demand for investment purposes – that is, the demand for gold coins and bars – could shift. In the first 6 months of 2015, over a fifth of gold demand in the country was for investment purposes. Under the scheme, a buyer purchases gold bonds from the RBI – at today’s prices, she buys a 100 gram certificate for Rs 2.6 lakh. Immediately, therefore, there will be 100 grams less of demand for imports.
Under normal circumstances, since the gold bond will have a 5-7 year tenure, RBI should buy a hedge in either local or global commodity markets in order to pay the customer the current value of gold upon redemption time. While the costs keep changing, a typical hedge costs 4-5% per year. In other words, if the RBI hopes to save Rs 100 of gold imports, it will have to spend 5% per year, or Rs 25 over a period of 5 years as hedging costs. Whether the gold bond exercise is worthwhile, of course, depends on whether the rupee is fragile – when the rupee was collapsing two years ago, it was the RBI’s promise to defray part of the hedging costs that played a big role in bringing in dollars. But what helps, in this case, is that since the gold bonds will be issued by RBI as part of the overall government borrowing, the scheme is self-financing – if RBI pays an interest of 2% on the gold bonds, it saves 5.7% given the current GSec rate. RBI doesn’t plan to hedge – unwisely, according to this newspaper – and will deposit this 5.7% in a Gold Reserve Fund which will be used to make good the difference to the customer in case gold prices go up. Since the government plans to monitor the Gold Reserve Fund for sustainability, perhaps buying hedges can be considered later. The 500 gram cap per buyer per year is a dampener, though, since most of those buying gold for investment purposes will be high net worth individuals.
Apart from fresh purchases, there is also the 20,000 tonnes or thereabouts of gold stock that India is estimated to have, and there is a gold monetization scheme that the Cabinet has cleared to try and get part of this. As in the bond scheme, this too will bear a small interest and, since the Gold Deposit Scheme failed due to its high threshold – 500 grams – of gold that could be deposited with banks, the new scheme lowers this to 30 grams. If the government can get even 1% of the gold stashed away, it means 200 tonnes of gold worth over $8bn that does not have to be imported. Though the scheme is theoretically available to all gold, it is only the bars/coins that will be monetized since owners will lose their ‘making’ charges on jewellery. All told, the gold schemes haven’t come a day too soon, though how well they will work remains to be seen.