The two gold-related schemes announced by the government last week are welcome, as any move that helps funnel idle assets into more productive sectors of the economy makes ample sense. After all, India spent $280 billion in gold imports in the last 10 years - more than the inflow from foreign institutional investors in both equity and debt in the same period. Annual investment demand for gold is estimated at 300 tonnes a year and holdings of gold are estimated at 20,000 tonnes, most of which are privately held lying idle in bank lockers and vaults. There is no doubt that the government will gain considerably by way of low-cost borrowings if the schemes succeed.
But will investors gain? The gold bond scheme may work, as it creates a financial asset equivalent to gold for investment purposes - with the added attraction of interest on the value invested. Allowing gold bonds as collateral for loans along with tax sops such as making the interest on gold bonds tax-free, exempting them from capital gains tax and providing indexation benefits to long-term capital gains on transfer of the bond, make gold bonds a relatively attractive proposition. But the gold monetisation scheme may not be as attractive. Under this scheme, the customer will get his gold ornaments melted, which will then be passed to banks against which a certificate will be issued. On maturity, the customer can redeem the gold value along with earnings from a modest interest rate. This has not succeeded in the past. State Bank of India, for example, has offered a gold deposit scheme for almost two decades, offering a one per cent interest rate. All that the scheme has yielded is eight tonnes of gold. For the scheme to succeed, the returns must be more attractive; households are unlikely to be enthused just because the minimum threshold is 30 grams compared to 500 grams under the SBI scheme. And then there is the mindset issue. Not many will be happy to see their ornaments melted down for a relatively small return. Although depositors will have the option of taking back gold after the maturity period, the purpose will not be served, as it will entail a loss in terms of making charges of 5-15 per cent. So if interest on the new gold deposit scheme is low, it will fail an individual's cost-benefit test. The government's only recourse seems to be temple trusts over which it has some control.
For this scheme, gold purity needs to be assessed from a recognised centre, which are few and far between. For banks, collecting gold from remote places and lending it to jewellers in certain pockets of the country will not be easy. But the biggest stumbling block will be the fear of tax scrutiny. There will be considerable apprehension over the likelihood of questions being asked about where the gold came from - a question even many individuals even after complying with the know-your-customer rules may find difficult to answer as the gold in question may have been lying with them for many years as wedding gifts or a legacy from earlier generations. The reputation of the tax department may not inspire much confidence here.