A significant portion of household savings is in the form of gold. This could be jewelry, coins or bars. There are no accurate estimates of just how much gold savings (or wealth) resides with households. This is partly because much of it is simply inherited for generations through bequests, and never enters any official records (barring wills and testaments). This holding represents wealth, but if it is never sold or mortgaged or liquidated, it does not become part of India’s financial system. This stock of gold keeps rising continuously every year with fresh accretion. India does not “produce” fresh gold. It is the highest importer in the world. During 2014 India imported 843 tonnes. In previous years, imports have been around 1000 tonnes annually. In the middle of 2013, due to a rupee crisis, the government imposed heavy controls and high import duty on the import of gold, and hence demand came down somewhat. But in the first quarter of 2015, demand is up again by 15%. China and India together accounted for 54% of global demand for gold in the first quarter of this year.
The troubling aspect of gold demand is that it is unproductive investment. More than half of India’s national savings does not go into the financial system, i.e. through banks and capital markets. It is parked in gold or real estate. This reduces the loanable funds available to fund new growth and job creation. To increase the depth and scope of the financial sector in India, it is essential that the gold savings be converted to financial savings. It is not as if demand for gold is totally irrational. Any grandma would advise you to keep some portion of the family wealth in the form of gold, and this has economic rationale. In times of high or uncertain inflation, bank deposits lose value, but gold does not. So gold is perceived to be a good inflation hedge. Unlike stocks and shares, buying and selling gold is seen as very easy, requiring very little paper work, demat and PAN accounts. Hence it can easily be liquidated. Finally gold is seen as the most preferred instrument to store long-term savings. There is simply no other instrument, which commands the same level of trust and respect.
For past two decades India’s policy makers have tried to make a dent in reducing the insatiable hunger for gold. Various gold deposit schemes were introduced, which have had very limited success. Few years ago there was a surge in gold backed Exchange Traded Funds (ETF’s), which were more popular. Most recently in the Union Budget of 2015, the Finance Minister announced a Gold Monetization Scheme (GMS). The rules for GMS were recently made public and will be notified shortly. Under GMS, the depositor takes his gold, in form of jewelry, coins or bars, to the bank. The amount can be as low as 30 grams. It is then evaluated for purity using a standardized X-Ray based purity-testing machine. The gold is then melted. And then you get a gold certificate in exchange, which will give you 2 percent interest, and full gold value on maturity. You may also get back your gold, but not as your original jewelry. The income from this scheme will be exempt from income and capital gains tax. The gold thus collected can also be used as the statutory CRR or SLR requirement by banks. It can also be supplied to the gems and jewelry industry, thus reducing the demand for imported gold.
All the schemes including the latest GMS suffer from one major drawback.
They require the submission of physical gold and verification of its purity. Even the gold ETF’s require the holding of physical gold. This severely curtails the scope for widespread adoption. What we need is a pure Gold Demat Scheme (GDmat), which is completely divorced from the physical metal. This would be sold as physical paper or in demat form, much like the savings certificate or the Kisan Vikas Patras, through various distribution channels like post offices, banks and even kirana stores. Each unit is of the GDMat would be equivalent to, say two grams of gold i.e. roughly Rs. 5000, and is sold at the daily price of gold. The GDmat paper would expire in 6 years (say), but can be traded or surrendered before maturity. Any time during its non-expiry it fetches the spot price of gold. So GDMat is gold for all practical purposes (price, liquidity, availability, mortgageability). The government will always stand guarantee to redeem the GDmat at prevailing price of gold. Once the public realizes how simple and practical this is, it will increase the demand for GDMat, and reduce the demand for the physical gold. It can even reduce the import of gold by about 10% with potential saving of Rs 60,000 crore of foreign exchange every year.
GDmat requires that the Government be ready to redeem the paper at any time at the prevailing price of gold. This exposes it to the risk of price fluctuation in gold. This risk can easily be hedged at a small cost, the details of which are available with the author. The success of GDmat requires sale through the largest network of distributors (much like small savings schemes), and a strong marketing push. Imagine Amitabh Bachchan selling GDmat as “asli gold” much like his campaign for Kalyan jewelers. The procedure for buying GDmat should be as simple as that for Kisan Vikas Patras, with diluted KYC, but requiring only either a PAN or Aadhaar id. There is no downside to this, and it can coexist along with the present gold monetization scheme. It does not involve cumbersome checking for purity of gold deposits. GDmat will surely increase the financial savings in the country.