Vivek Rajvanshi, Fellow (IIMC), is Assistant Professor, Finance and Control, Indian Institute of Management Calcutta. His research interest areas are Commodity Futures Markets, Volatility Modelling, Risk Management.

Gold as an alternative investment class is equally important as bond market and equity markets. It has been observed that gold not only provides enough returns to beat the inflation but also involves less risk as compared to equities and other financial instruments. Low or negative correlation of gold returns with the equities and other financial assets’ returns qualifies gold as a natural investment instrument for diversified portfolios. In addition, during economic recession, when equity markets perform badly, it has been observed that gold provides safe heaven for investors and investments moves from equity market to gold market.

In India, gold is used in wedding gifts, religious donations and for investment purposes. India imports around 800 to 1000 tonnes of gold every year which is a major contributor (around 25% to 30%) of trade deficit. This is highest gold demand of any country in the world. As Indian importers need to pay in foreign currency, therefore it has impact on the forex rates as well. In order to control for the trade deficit, Government of India has launched several schemes in the past. In 1992 gold deposit scheme (GDS) was launched by the GoI, but low interest rates on gold deposit and a non-transferrable security feature and low participation of individuals were the two main reasons of the failure of the scheme. In the year 2013, GoI imposed excise duties, banned gold coins import. GoI also launched 80:20 scheme, where 20% of the gold imported must be exported in the same or other form. But reporting of export of substandard jewelry forced government to abandon 80:20 scheme. These schemes are not very successful and had a very little impact on the import of gold.

Why, gold Monetization Scheme?

As we mentioned earlier that India imports around 800-1000 tonnes of gold every year and it contributes significantly in trade deficit and current account deficit. It is expected that India has around 20,000 tonnes of gold worth around $ 800 billion lying idle with the households, banks, temples, trusts etc. Any scheme that can mobilize around 1% of the gold will bring down around 25% of gold import every year. This may help in stabilizing currency and trade deficit.

Earlier gold deposit scheme allowed minimum deposit of 500 grams of gold and therefore it was not attractive for the individuals and low worth investors. In the new scheme named gold monetization scheme (GMS) launched on 5^th November 2015, investors are allowed to deposit minimum 30 grams of gold that may be either in the form of jewelry or bullion. Investors are exempted from any tax liabilities such as capital gain, wealth or income tax on the interest payments received on gold deposits. In spite of the benefits mentioned above, GMS had attracted only 0.9 tonnes of gold till 20^th January 2016. To make it more successful government with the consultation of other stakeholders has modified the scheme and new guidelines has been issued through master direction on GMS on 21^st January, 2016 by the Reserve Bank of India. The modifications allow premature redemption after three years for medium term gold deposits and after five years for the long term gold deposits. Investors can provide gold directly to the refiners or through the purity testing centers. In order to increase the number of licensed refiners, Bureau of Indian Standards (BIS) has relaxed the licensing conditions. Now licensed jewelers are also allowed to act as collection and purity testing centers. This move is expected to increase around 10,000 centers across the country.

Through GMS government is expecting to consolidate gold reserves which may be use for the currency stability and for the other purposes. Government can sell the collected gold in the open market or short the gold in the derivative market with a carry which may reduce the cost of financing for the government.  In future, government can also issue financial instruments backed by gold which may provide cost effective and secure way of financing.

GMS will increase the supply of the gold which will help in decreasing the imports of gold and reduce the cost for jewelers. Investors will get interest on gold deposits which is lying idle. It will reduce the cost of storage of the gold and it will reduce security issues faced by households in keeping physical gold.

How to Invest in GMS?

The first step to invest in GMS is to get purity verification done through the hallmarking centers authorized by the GoI.  Then, investors need to open a gold saving account with banks where investors can deposits the verified gold. The interest rate will be decided by the concerned bank and it will be around 2% per year. Investors can deposit gold for the short term (1-3 years), medium term (5-7 years) and for long term (12-15 years). Interest rate will vary depending on the maturity of the deposit. E.g, for the gold deposit for medium term of 5-7 years interest rate applicable is 2.25% and for the long term deposits for 12-15 years interest rate is 2.5%.

Banks can use the gold deposits for their CRR/SLR requirements and can also sell or trade in commodity market. Jewelers can also take gold loan from the banks after opening gold loan account. Banks can collect gold from investors for a maximum period up to 15 years and can accordingly auction or provide loans to the jewelers or industrialists.

Issues and challenges

As we mentioned earlier that around 20,000 tonnes of gold is lying idle with the households, trusts etc. Around 60% of this is lying with the rural households. However the scheme allowed to deposit minimum of 30 grams of gold but still for the purity test individuals has to come from remote areas to the authorized centers which may be a bit challenging. Individuals enjoy the gold in the form of jewelry as they buy gold not only for the investment purpose but for ornamental value as well. Gold is a very liquid asset and can be sold easily in any form in nearby markets by the household if they want to liquidate it. In GMS there are restrictions for the minimum investment horizon. Investors who buy gold to gift ornaments at marriages or other occasions may find this scheme not very attractive.

Cost of purity verification, melting charges and stone removal charges would be borne by the investors. These costs may account around 2% of the total gold value or may be more than the interest earned in a year on the gold deposits. As customers have been provided the option to redeem either in cash or gold, this may increase the risk of the banks.  However, banks are free to hedge their positions against the short term deposits.

In short, GMS is launched with the objective to mobilize the idle gold for the productive use. Investors can get interest on the idle gold, where banks can use it for the CRR/SLR requirement and to provide gold loans to the jewelers, or can sell in the open market that ultimately help in reducing the gold imports and to maintain trade deficit. Any individual, firm, trusts, mutual funds can invest in this scheme. Minimum 30 grams of quantity of gold can be deposited in this scheme for short, medium and long term. Interest earned and any capital gain would be exempted from income tax. Premature redemption is allowed after a lock in period with some penalty on interest payments. At the time of the redemption investors will have the option to receive the payment either in cash or in gold.

******