Tuesday, July 7, 2015

Metal to Paper: India’s Sovereign Gold Bonds

[The following guest post is contributed by Rishi A, a fourth year student of Hidayatullah National Law University]

The Government of India recently released a concept paper on Sovereign Gold Bonds. It has been proposed that these bonds would carry a fixed rate of interest of around 1.5-2%, which can be further raised by individual banks, and will be redeemable at the price of gold at the time of maturity. The Government of India, through the Reserve Bank of India, has proposed that it will issue these gold bonds, with the hopes of reducing the rapidly increasing gold importing costs.

India consumes on average 1000 tonnes of gold every year, its second highest imported product is gold after oil,[1]  and it is the world’s top gold importer.[2] Hence, if implemented effectively, this proposal has the potential to drastically bridge our Current Account Deficit.

Non-banking financial companies (NBFCs) and Post Offices will be allowed to collect money and redeem the bonds on behalf of the Government. These bonds are to be issued in denominations of two, five and ten grams of gold with a minimum tenor of five to seven years.

This scheme is essentially being proposed to convert the massive investment demand for physical gold into paper demand. Speculating that a number of investors buy gold in forms of coins and bars and store them in private safes as forms of investment, the government has come up with this format, in which the investment will still be based on the prices of gold but on paper. The Government aims to issue bonds worth 135 billion rupees or $2.12 billion or equivalent of 50 tonnes of gold in the first year. It is also speculated that if this scheme is fully subscribed, it could possibly result in saving $2 billion on gold imports at current prices.

But one downside to this could be the tax related aspect. The report notes that there will be capital gain taxes imposed on the bond which will be similar to the ones imposed on physical gold purchases. This tax is mainly avoided by most of the Indian consumers, since they typically buy coins and bars in cash.[3]

The biggest factors that the Government will have to take into account to make this scheme attractive is not just the fluctuating price of the metal but also the target group of this particular scheme.

Firstly, price fluctuation is a major concern that has to be taken into consideration. The SGBs will only be as good as investing in physical gold if it provides the same return as the actual metal would.

One of the major factors affecting the prices of gold is its demand in countries like India and China.[4] India individually accounts for approximately 30% of the global demand for gold.[5] But with the recent import regulations placed by the Indian Government to curb the massive current account deficit by restricting gold imports has led to a decrease in the demand for gold. In 2014, India’s investment demand for gold was at 181 tonnes against an average annual demand of 345 tonnes from 2010 to 2013. On the other hand, the jewellery demand for gold has increased from 613 tonnes in 2013 to 661.4 tonnes in 2014.[6] According to the World Gold Council, demand for gold in India fell 39% from a year earlier in the quarter ended June to 204.1 tonnes. Investment demand — buying of gold in the form of coins or bars rather than jewellery — plummeted even further, losing 67%.[7]

Furthermore, another factor that largely affects the price of gold is the U.S. Dollar and the Interest rates of the Federal Reserve in the United States. With the dollar performing better in last few quarters against all currencies and with mounting speculations of a hike in the interest rates by the Fed, the price of Gold is estimated to fall, proving to be another concern to the Government’s proposed scheme.[8]

This loss in demand for gold, would inherently in long term lower the prices of gold. Consequently, having invested in gold with the hope to generate profit after the maturity period, falling demand will only lead to a lower rate of return. More importantly, it is pertinent to note that the investment demand for gold has been plummeting. This could be a cause of concern as this is the sector that the Government wishes to target with the Sovereign Gold Bonds.

Adding to this, the capital gains tax that is speculated to be imposed on the return of investment, after the maturity period, will further deter people from wanting to invest in the Sovereign Gold Bonds. Therefore, the Government needs to provide concessions to investors to incentivise the scheme and thus generate the momentum required.

Secondly, rural India accounts for 60% of the total gold consumption imported into the country.[9] People here generally use their lives’ savings to buy gold, as a mode of investment, especially for times of crisis or for weddings that have to be arranged.

In its Vision 2020 document for the country, unveiled at the second edition of the India International Bullion Summit organised by the India Bullion and Jewellers Association, the World Gold Council observed the importance of Gold in India not just a commodity to invest in, but also a part of the Indian culture. The Council observed that gold is much more than just a precious metal. It is part of the fabric of Indian culture and an inseparable part of its belief system. For most Indians, gold is sacred; an embodiment of divinity and a symbol of purity, prosperity and fortune that can adorn the body and celebrate life.[10]

Hence, another major challenge that the Government will face is convincing the rural population, which constitutes a large part of the physical gold consumers to shift from investing in physical gold to paper gold. More importantly, since it is the imports of the jewellery gold that has seen a consistent rise, it is more important for the Government to show the people of the country that investing in the Sovereign Gold Bonds is more profitable and a better form of security as against gold jewellery.

The Government along with the Sovereign Gold Bonds has also proposed the Gold Monetising Scheme, wherein, an interested party can deposit their gold and they receive a return after the maturity period with interest. The catch, however, is that the depositors are required to melt their gold deposits and have them tested, whose costs have to borne by the depositor.[11]

While this scheme is also largely targeted at gold investors, considering the fact that investor demand for gold is dropping and jewellery demand for gold is the one which seems to see no limits, especially in a country like India, the Government must focus on reducing the demand for jewellery gold. India is estimated to have more than 20,000 tonnes of the gold lying idle in its households. Even a portion of this quantity will resolve a lot of problems faced by the country at this point of time. For this, the Government must develop a method to convince the rural population, the largest consumer of imported gold for jewellery, to seek alternate forums of investment, like the ones promoted by the Government.

- Rishi A




[1] Rajendra Jadhav and A. Ananthalakshmi, ‘India proposes gold-linked bonds to lower bullion imports’, 19th June, 2015, available at: http://in.reuters.com/article/2015/06/19/india-gold-bonds-idINKBN0OZ09B20150619
[2] Kiran Sharma, ‘Modi Government aims  to turn idle gold into cash’, 11th March, 2015, available at: http://asia.nikkei.com/Politics-Economy/Economy/Modi-government-aims-to-turn-idle-gold-into-cash
[3] Rajendra Jadhav and A. Ananthalakshmi, ‘India proposes gold-linked bonds to lower bullion imports’, 19th June, 2015, available at: http://in.reuters.com/article/2015/06/19/india-gold-bonds-idINKBN0OZ09B20150619
[4] Annie Gilroy, ‘US Economic Data and Other Factors Shaping Gold Prices Now’, 22nd May, 2015, available at: http://marketrealist.com/2015/05/market-malleable-gold-shapes-price-precious-metal/
[5] Shenoy Karun, ‘3 Kerala Companies have more Gold than Sweden, Singapore, Australia’, 14th December, 2014, available at: http://timesofindia.indiatimes.com/business/india-business/3-Kerala-companies-have-more-gold-than-Sweden-Singapore-Australia/articleshow/45508697.cms
[6] Sandeep Singh, ‘Gold Monetisation Scheme: A 24-carat question, Interest Rates, 22nd May, 2015, available at: http://indianexpress.com/article/india/india-others/gold-monetisation-scheme-a-24-carat-question-interest-rates/
[7] ‘Has Gold become a bad Investment in India?’, 18th August, 2014, available at: http://blogs.wsj.com/indiarealtime/2014/08/18/has-gold-become-a-bad-investment-in-india/
[8]Reasons for the Recent Decline in Gold Prices’, 9th December, 2014; available at: http://www.forbes.com/sites/greatspeculations/2014/09/12/reasons-for-the-recent-decline-in-gold-prices/
[9] Sutanuka Ghosal, ‘Gold trade to be hit by Indonesian imports, fall in rural demand’, ET Bureau, 26th May, 2015, available at: http://articles.economictimes.indiatimes.com/2015-05-26/news/62672007_1_jewellery-prices-bachhraj-bamalwa-gold-jewellery
[10] Shivom Seth, ‘World Gold Council wants India to put idle Gold Stock to Use’, 7th Otcober, 2014, available at: http://www.moneyweb.co.za/uncategorized/world-gold-council-wants-india-to-put-idle-gold-st/
[11] Sandeep Singh, ‘Gold Monetisation Scheme: A 24-carat question, Interest Rates, 22nd May, 2015, available at: http://indianexpress.com/article/india/india-others/gold-monetisation-scheme-a-24-carat-question-interest-rates/

1 comment:

Aakash Agarwal said...

Great article shared you. It's very much helpful for everyone.