Gold Monetization

How effective will this scheme eventually be?

The draft Gold Monetization Scheme has been put up by the Ministry of Finance for public comments. Principally, it is different from the 1999 scheme in 2 ways. Firstly, the minimum entry point has been lowered from 500 gm to 30 gm. Second, the setting of interest rates has been left to the discretion of the banks.

Costs are still high

That was the bane of the old gold monetization scheme and that problem continues. If you add up the cost of hallmarking, assaying, purifying, storage it adds up to nearly Rs.1400-1500. That means even if you deposit 60 grams of gold, your first year interest will be eaten away by costs. That could be a major disappointment. Consequently, the reduction of entry level to 30 grams may not really add any practical value.

Rate of interest paid

The old scheme paid just about 0.75%-1% interest on the gold deposits. That made it prima-facie unattractive. What will happen currently? The normal jewelry leasing rates are hovering in the range of 3.5%-4%. Assuming that banks will like to maintain a spread of 2% to cover their costs and risk, the best rate that can be paid will be about 1.5%. Even assuming that gold is a hedge against inflation, this interest rate may not really act as an incentive for investors to buy into gold deposits.
How will banks look at it?

Banks have certain incentives they will get on the gold monetization scheme. Firstly, these deposits will be eligible as CRR and SLR. Secondly, banks will also be permitted to convert this gold into foreign exchange to give foreign currency loans. There are a couple of hitches. CRR at 4% is already quite low. Banks are already holding excess SLR bonds by choice. That will not really be affected. The biggest challenge for banks will to manage the spread between what jewelers are willing to pay and what depositors expect. Within this spread, the bank will have to manage its costs and business risk.

It is the economy, stupid!

As Bill Clinton said as part of his second campaign in 1996, “It is the economy stupid”. If things go well for the scheme, the economy has a lot to gain. Indian households have stashed 22,000 tons of gold and that will come out into the open market. The balance of trade has been consistently hit by gold imports and that can be partially, if not entirely, substituted with domestic gold.

The household gold is worth close to $1 trillion. Even if a part of that comes into the system and generates liquidity, the multiplier effect could be huge. Mr. Modi realizes that low inflation and cheap oil may prove to be ephemeral. The gold stash could be his big bet on India! ©

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