Success of the new gold monetisation scheme depends on incentives offered for banks and depositors. Depositors want higher interest rates, while banks want regulatory exemptions. If these are not provided, then it risks being a damp squib, like the one in 1999, says Nomura
Presenting the Union Budget, Finance Minister Arun Jaitley had announced gold deposit accounts to utilise the 20,000 tonnes available within the country. On Tuesday, the government put in the public domain the draft guidelines for the interest-bearing gold monetisation, or deposit scheme (GMS). However, according to Nomura, unless there is an incentive for all participants involved, the new GMS could also risk seeing low participation and more clarity will emerge once the final guidelines are out.
In a research report, Nomura said, "The jury is still out on this and it depends on the incentives on offer for both the banks and depositors. From a depositor’s perspective, as the gold has to be stored in standardised coins, households are unlikely to deposit their jewellery under these schemes and the target customer (for a bank) would be households or institutions that hold gold as an investment (about one-third of the total gold demand in India)."
The objectives of the GM scheme, under which as little as 30 grams can be deposited, is three-fold: Mobilise the gold, give a fillip to the gems and jewellery sector by making gold available from banks on loan and reduce the reliance on imported gold and conserve foreign exchange.
"The minimum quantity of gold that a customer can bring in is proposed to be set at 30 grams, so that even small depositors are encouraged. Gold can be in any form, bullion or jewellery," the guidelines, said, adding the depositors can redeem the gold either in cash or in physical form.
According to Nomura, the lower ticket size (minimum deposit of 30 grams) and tax exemptions could help attract more depositors and correct some of the faults with the 1999 gold deposit scheme. "However," it said, "interest rates on gold deposits will need to be much higher than those currently offered (0.75-1%) to make it an attractive proposition. However, as small gold deposits would entail much larger transaction costs in terms of handling, storage and transportation charges, banks may not offer attractive interest rates."
A study by Errol D’Souza shows that if depositors are paid 2-3%, then the total cost of assaying plus other cost for banks would stand at 4.9-6.95% (Figure 2). There may be economies of scale if the banks are able to mobilise large quantities of idle gold held by institutions such as temple trusts in India. However, this would likely be a challenge as temple trusts have historically had very low participation in the existing gold scheme.
Similarly, banks may need an incentive to garner gold deposits as this does not form a part of their core business. If gold deposits are allowed to count as cash reserve ratio or statutory liquidity ratio (CRR/SLR) requirements, then banks could offer higher deposit rates. However, without regulatory exemptions, banks themselves may not be keen on pushing this scheme, Nomura says.
Utility of gold deposits for banks
One of the challenges of making the gold scheme a success is creating incentives for banks. The government has proposed the following uses of gold deposits:
CRR/SLR: Banks may be permitted to use the gold deposits as part of their cash reserve ratio (CRR) and statutory liquidity ratio (SLR) requirements.
Foreign Currency: Banks will be allowed to sell gold in exchange for foreign exchange, which can be used to lend to exporters/importers.
Coins: Banks can use the gold deposits to sell gold coins to their customers.
Exchanges: Banks can buy or sell on domestic commodity exchanges, where their mobilised gold can be delivered.
Lending to jewellers: As discussed above, the gold deposits can be used to lend to jewellers who use the gold as their raw material.
A comparison with the 1999 scheme
This is not the first time a gold deposit scheme has been implemented. In 1999, Indian policymakers introduced a similar scheme, but it turned out to be a damp squib for several reasons, some of which the government has tried to fix.
First, the gold deposit scheme of 1999 had no real incentives for depositors. Even though the scheme qualified for tax exemptions (wealth tax, capital gains tax and income tax), interest rates were very low (0.75% for a 3-year deposits and 1% for 4 to 5-year deposits), the ticket size was large (minimum deposit of 500 grams) and the tenure was too long (3-7 years). This made it unattractive for households, resulting in very little gold deposit accretion. In this new proposed GMS, the government has lowered the minimum tenure to 1 year and the minimum deposit to 30 grams. This should make the product accessible to a wider population.
Second, the 1999 scheme also lacked an incentive for banks. While banks were exempt from maintaining cash reserve ratios (CRR) on the gold deposits (10% in October 1999), they had to maintain the minimum CRR (3%) and also the statutory liquidity ratio (SLR) of 25%. The 2015 scheme, in contrast, proposes (at the draft stage) that gold deposits be held as part of CRR/SLR requirements.
Third, banks’ interest was also muted because they lacked the facilities for melting the jewellery, testing its purity and warehousing it. Plus, banks required pre-approval from the RBI for launching the scheme, making it a cumbersome process for them. Although some of these conditions such as prior approval from the RBI were subsequently relaxed in 2013, the scheme failed to gain traction. Under the 2015 scheme, banks will partner with purity testing centres and refiners to outsource the assaying and storage of gold, reducing the costs for banks.
The Turkish example
Nomura also cited the example of Turkey, which was able to increase the country's gold reserves by more than 200 metric tonnes (MT) through similar gold deposit scheme. As in India, Turkish households traditionally invest their savings in gold, particularly because gold is exempt from taxation.
Faced with a bloated current account deficit in 2011, the Turkish central bank introduced a gold scheme in which banks were allowed to substitute part of their reserve requirement liabilities with gold. Banks in Turkey were required to hold 10% of their deposits (CRR equivalent) as cash.
Under the scheme, 30% of these liabilities could be held in gold instead of cash. Consequently, banks promoted various innovative schemes to attract gold deposits, such as gold accounts, which enabled depositors to trade gold, gold structured products and interest bearing gold savings accounts. They recycled the gold from these deposits into gold bars and deposited them with the Turkish central bank.
The scheme not only helped to monetise idle gold in the country, exporters also leveraged on gold loans, driving up jewellery exports from Turkey. To further promote the recycling of gold within the country, bank ATMs were also upgraded to dispense gold. As a result of the scheme, since 2011 banks have increased their gold reserves with the Turkish central bank by more than 200 MT.
Macro implications of the Gold Monetisation Scheme
According to Nomura, if the GMS is successful, then it could have several positive implications for the Indian economy:
First, it could lower gold imports by bringing into circulation domestically-held idle gold from households and institutions such as temple trusts. According to the World Gold Council’s estimates, Indian households and other institutions own around 22,000 MT of gold. Even if the scheme is able to create only 100 MT in gold deposits over the next few years, it could help reduce the gold import bill by 10% ($3 billion) annually.
Second, the increased availability of gold due to this scheme could reduce transaction cost for jewellers and, as in the case of Turkey, end up boosting exports.
Third, it would enable households and temple trusts to monetise their gold assets, on which they currently earn nothing.
And fourth, if banks are allowed to include these deposits in their CRR requirements, it could help release funds for onward lending in the economy.
"Depositors want higher interest rates, while banks want regulatory exemptions. If these are provided, then the scheme may be successful. If not, then it risks being a damp squib, like the one in 1999," Nomura concluded.
For a gold depositor: When a depositor approaches a bank to open a gold savings account, the bank will first test the purity content of the gold being deposited. In a purity
testing centre, a preliminary machine test will be conducted to estimate the amount of pure gold in the jewellery. If the customer does not agree with the result, the jewellery
will be returned to the customer. If the customer gives his consent, the jewellery will be melted and the customer will be given a certificate of gold deposit, attesting the purity and amount of gold deposited. Next, the bank will open a Gold Savings Account for the customer, and credit the amount of gold to the customer’s account. Both the interest and principal payment paid to the customer on this account will be valued in gold (grams).
Storage of gold: The purity testing centre will transfer the gold to refiners who will store the gold bars in warehouses (unless banks prefer to store it themselves). Hence, the GMS involves a tripartite agreement between the bank, the purity testing centre and refiner, detailing the arrangement (service fee, storage costs, etc) between them.
For a gold borrower (jeweller): Since banks now have gold deposits, they can lend the same to jewellers. Jewellers can open a Gold Loan Account with a bank. Once the loan is sanctioned, the jeweller will receive physical gold from the refiner. The repayment by the jeweller will be made in cash.