Economics For Everyone – Bonding With Gold
Background News
- PM Narendra Modi launches 3 gold schemes
- PM Modi Launches Gold Schemes, Coin with Ashok Chakra
- PM Modi Launches Gold Monetisation, Sovereign Bond Schemes
- Gold Deposit Scheme to Offer 2.5% Interest, to be Launched on November 5
- PM to Launch 'India Gold Coin', Other Schemes on November 5
- RBI Fixes Gold Bonds Issue Price at Rs 2,684/Gram
Gold, the precious metal has always been a status symbol from the time immemorial. It has always been the symbol of the riches, affluence and pride for the human society. It is a beautiful, colourful, dense, malleable, ductile and indestructible matter besides being scarce in terms of its presence in the nature. The above properties of the gold makes it most wanted commodity in the world. Gold has long been considered the most desirable of precious metals, and its value has been used as the standard for many currencies. Gold has been used as a symbol for purity, value, royalty, and particularly roles that combine these properties.
It influences the events in the global economy. It is one of the most sought after investment portfolio. It expressed as a symbol of love and affection across many regions and families of the world. It carries memories across generations and cultures. Gold has provided an important store of wealth to diverse investors, from individuals to institutions, for centuries. The history of gold is very much the history of civilisation. From the time that early man found the first grains of gold, this sparkling yellow metal has fascinated mankind. Wars have been fought over it, women have adored it, and men have killed for it and longed to own it.
Gold and the Indian Economy
India is the world's largest single consumer of gold, as Indians buy about 25% of the world's gold, purchasing approximately 800 tons of gold every year, mostly for jewelry. India is also the largest importer of gold; in 2008, India imported around 400 tons of gold. Indian households hold 18,000 tons of gold which represents 11% of the global stock and worth more than $950 billion. The annual consumption of gold which was estimated at 65 tons in 1982, has increased to over 800 tones presently about 80% is for jewellery fabrication (mainly over 22 carat purity) for domestic demand, 15% for investor demand and barely 5% for industrial use.
The Indian Government recently (November 2015) launched three gold related schemes, including 'India gold coin' bearing Ashok Chakra, gold monetisation and gold bond schemes to tap the festive season ahead of Dhanteras and Diwali.
The gold monetisation schemes (GMS) aims to tap household gold stocks of around 22,000 tonnes, the sovereign bond scheme would help shift part of the estimated 300 tonnes of physical gold bars and coins purchased every year in the country for investment into the demat gold bonds.
Lauding the launch of three gold schemes by Prime Minister Narendra Modi, World Gold Council (WGC) said the initiative would expand consumer choices and help the economy.
The three schemes announced by the government are
- Sovereign Gold Bond Scheme
- Gold Monetization Scheme
- Gold Coins Scheme
Sovereign Gold Bond
Instead of buying gold in physical form investors can park their money in bonds which are backed by gold. The bonds will be available both in demat and paper form. Sovereign Gold Bond has more or equal advantage against the physical gold. The bond will be issued by RBI on behalf of the Government of India. The bond would be restricted for sale to Investors (resident Indian entities) who can buy a minimum of 2 units or 2 grams and a maximum at 500 grams per person per fiscal year.
Gold Monetisation Scheme
Resident Indians (individuals, HUF, trusts, including mutual funds/exchange traded funds registered under SEBI norms) can make deposits under the scheme. The minimum deposit at any one time will be raw gold (bars, coins, jewellery excluding stones and other metals) equivalent to 30 grams of the precious metal of 995 fineness. There is no maximum limit for deposit under the scheme and the metal will be accepted at the Collection and Purity Testing Centres (CPTC) certified by the Bureau of Indian Standards.
Gold coins
-The coins will be available in denominations of 5 and 10 grams. A 20 gram bar or bullion will also be available. About 15,000 coins of 5 gm, 20,000 coins of 10 gm and 3,750 gold bullions will be made available through MMTC outlets.
- The Indian Gold coin is unique in many aspects and will carry advanced anti-counterfeit features and tamper proof packaging that will aid easy recycling.
- These coins will be distributed through designated and recognized MMTC outlets.
- The first ever national gold coin of India
Details of the Schemes
Sovereign Gold Bond
- The RBI has fixed the public issue price of sovereign gold bonds at Rs 2,684 per gram.
- These bonds will be issued in different denominations of grams of gold or other denominations.
- Applications for the bond will be accepted from November 5-20. The Bonds will be issued on November 26.
- The Bonds will be sold through banks and designated post offices as may be notified.
- The borrowing through issuance of Bond will form part of market borrowing programme of Government.
- Bonds can be used as collateral for loans. The loan-to-value (LTV) ratio is to be set equal to ordinary gold loan mandated by the Reserve Bank from time to time.
- Know-your-customer (KYC) norms will be the same as that for purchase of physical gold. KYC documents such as Voter ID, Aadhaar Card/PAN or TAN /Passport will be required.
- -The interest on Gold Bonds shall be taxable as per the provision of Income Tax Act, 1961 (43 of 1961) and the capital gains tax shall also remain same as in the case of physical gold. Bonds will be tradable on exchanges/NDS-OM from a date to be notified by RBI.
- The Bonds will be eligible for Statutory Liquidity Ratio (SLR). Commission for distribution shall be paid at the rate of 1% of the subscription amount.
Some other Details….
- Sovereign gold bonds will be issued by the Reserve Bank of India. They will be denominated in particular amount of gold and linked to the price of the yellow metal. If the price of gold increases, the value of the bond goes up, benefiting investors.
- Investors can buy a minimum of 2 units or 2 grams and a maximum at 500 grams per fiscal year. The Reserve Bank has fixed the public issue price at Rs 2,684 per gram for the sovereign gold bonds. This means the minimum investment comes to around Rs 5,400.
- Investors will get a fixed rate of interest of 2.75 per cent per annum (payable every 6 months) on the initial value of investment.
- The gold bonds would also be available in demat format, so investors will not have to worry about storage unlike physical gold.
- The bonds have a maturity period of 8 years, with exit option from the fifth year. Holdings can be redeemed in multiples of one gram. The redemption price will be based on prevailing gold prices.
- The bonds will be listed on the exchanges so investors may get an option to exit even before five years if volumes are good.
- Gold bonds will be sold through banks and designated post offices. They can be used as collateral for loans from financial Institutions.
- TDS (tax deducted on source) is not applicable on the interest component, but interest earned on gold bonds will be added to the income and taxed. Capital gains will be taxed at tax slab if these bonds are sold before 3 years. If sold after 3 years, capital gain tax of 20 per cent with indexation benefits would apply. Indexation is a process by which the cost of acquisition is adjusted against inflation in the value of asset.
- Gold bonds offer an exposure to gold while also offering interest, a feature that is not present in other avenues like ETFs and gold mutual funds or even physical gold.
Source: TOI
Gold Bond Vs Gold ETF
Gold bonds and ETFs both track gold price. But the interest payout on gold bonds—which is proposed to be linked to international rate of gold borrowing, or at least 2%—can render them more attractive. In contrast, ETFs only offer returns that track the change in price of gold.
Another major difference lies in expenses. Unlike the bonds, ETFs have an expense or management cost attached. The average annual expense ratio for gold ETFs is around 1.03% of total assets (maximum of 1.07% and minimum of 0.96% among existing funds).
What this means is that when you redeem your bond after, say, 5 years, you will not only be able to capture gains (or losses) on the price of gold within that period, but also earn 2% interest every year (the current draft guidelines have, however, not specified whether the interest will be calculated as simple interest or compounded). In contrast, gold ETFs only return the gains (or losses) on price of gold post-expenses.
On the flip side, the amount you can invest in gold bonds every year is restricted—proposed limit per person per year is 500 gm. There is no such limit for gold ETFs. Moreover, ETFs are accessible and tradable easily on stock exchanges.
Gold ETFs are usually sold by mutual fund distributors, which is likely to continue. These are marketed to high net worth and retail individuals, but mostly in large cities. On the other hand, the gold bonds may be available through post offices and banks, which will help in reaching out to retail investors even in smaller towns and villages.
While gold ETFs are a familiar route, especially for mutual fund investors, gold bonds will be issued on behalf of the government, which may appeal to the more conservative individual.
Gold Monetisation Scheme
– Gold Monetisation Scheme can earn up to 2.50 per cent interest rate on their idle gold.
– Interest rate on Medium and Long Term Government Deposit (MLTGD) are 2.25 per cent and 2.20 per cent, respectively.
– The tenor of medium term would be between 5-7 years while long term would for 12-15 years tenure.
– The deposit under MLTGD category will be accepted by the designated banks on behalf of the central government.
-Interest on deposits under the scheme will start accruing from the date of conversion of gold deposited into tradable gold bars after refinement or 30 days after the receipt of gold at the Collection and Purity Testing Centres (CPTC) or the bank’s designated branch, as the case may be and whichever is earlier.
– The principal and interest of the deposit under the scheme will be denominated in gold.
– The gold received under MLTGD will be auctioned by the agencies notified by the government and the sale proceeds will be credited to government’s account held with RBI.
– Reserve Bank of India will maintain the Gold Deposit Accounts denominated in gold in the name of the designated banks that will in turn hold sub-accounts of individual depositors
Gold Coins:
COIN FEATURES
- Purity -The Indian gold coin will be of 24 karat purity and 999 fineness.
- Hallmarked -All coins will be hallmarked as per the BIS standards.
- Security -The tamperproof packaging and advanced anti-counterfeit features on the coin cover make s it very safe and easily recyclable.
- Availability- This coin will distributed through designated & recognised MMTC outlets.
But according to some experts the government faces the following challenges in implementing these schemes.
Government will find it difficult to pull off the gold monetization scheme. According to them unless the banks and the government decide to offer attractive returns. Not many people would want to see her long-preserved, family-inherited, emotionally attached, piece of yellow metal lose its identity and ‘feel’ by melting it, for meagre returns. Instead of earning such low returns, they would rather prefer to keep the ornaments in the bank locker. Given the cultural and traditional affinity of Indians to their family-owned gold ornaments, the only incentive for them to come forward and pledge their gold under the scheme is higher returns. Thus, the success of this scheme depends on the rate of interest offered. Many a time, pledging gold is seen as something like a social ignominy. In the past, the government has always been trying out every possible method to cut down the gold consumption of Indian households -- sharply hiking import duties and prodding public return the idle stock of gold lying in domestic households and temples back to circulation. Yet another big challenge in waiting for the government, while rolling out the gold monetisation scheme, will be checking the inflow of black money through this channel. According to experts, there is no clarity on this part in the guidelines. Unlike other assets such as real estate, it is highly difficult to verify the ownership of gold, especially if the gold is old. Those, who have unaccounted wealth stored in the form of gold ornaments and bars, will find this as a golden opportunity to legitimise their ill-gotten wealth. They can split the gold into small installments and approach banks either by themselves or a benami.
The case of SBI scheme- a lost chance
Back in 1999 State Bank of India had launched Gold Deposit Scheme (GDS) when it saw big opportunity there. It was the time of global economic turmoil and the yellow metal was expected to rise in demand. If you were rich and possessed lots of gold (which you did not use), you could deposit it at the bank and earn a small interest on it.
Also, investors were exempted from wealth tax, capital gains tax and income tax on interest earned. In case of exigencies you could pledge the GDS and avail loan. And of course, you would save on storage charges as well. Overall it made sense for wealthy gold lovers to keep their metal in SBI Gold Deposit Scheme. However it was not meant for everyone since minimum deposit was 500 grams- not an that the amount small investors would possess. So the scheme was not very successful.
According to experts, 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.
But as experts observe, in the present scheme, the lower ticket size of 2gms in the gold bonds and the minimum of 30 gms in the gold monetisation scheme, lower tenure and tax exemptions could help attract more depositors and correct some of the faults with the 1999 gold deposit scheme. There may be economies of scale if the banks are able to mobilise large quantities of idle gold held by which would also lower the cost of operation for the Government and banks.
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.
Thus, 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 in the present proposed scheme:
- 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.
During the earlier schemes, the banks also 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 Case of Turkey – Successful Scheme
Experts point out the successful scheme in Turkey. 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.
Recent Research Analysis:
According to a study by the Nomura group, if the Gold Monetisation Scheme 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. Source: www.moneylife.in |
It is in this context it is important to know about the concept of Gold Certificates
Gold Certificates allow gold investors to avoid the risks and costs associated with the transfer and storage of physical bullion (such as theft) by taking on a different set of risks and costs associated with the certificate itself (such as commissions, storage fees, and various types of credit risk).
A gold certificate in general is a certificate of ownership that gold owners hold instead of storing the actual gold. It has both a historic meaning as a U.S. paper currency (1863–1933) and a current meaning as a way to invest in gold.
Banks may issue gold certificates for gold which is allocated (non fungible or fully reserved) or unallocated (fungible or pooled). Unallocated gold certificates are a form of fractional reserve banking and do not guarantee an equal exchange for metal in the event of a run on the issuing bank's gold on deposit. Allocated gold certificates should be correlated with specific numbered bars, although it is difficult to determine whether a bank is improperly allocating a single bar to more than one party.
Banks may issue gold certificates for gold that is allocated (non-fungible) or unallocated (fungible or pooled). Unallocated gold certificates are a form of fractional-reserve banking and do not guarantee an equal exchange for metal in the event of a run on the issuing bank's gold on deposit. Allocated gold certificates should be correlated with specific numbered bars, although it is difficult to determine whether a bank is improperly allocating a single bar to more than one party.
The first paper bank notes were gold certificates. They were first issued in the 17th century when they were used by goldsmiths in England and the Netherlands for customers who kept deposits of gold bullion in their vault for safe-keeping. Two centuries later, the gold certificates began being issued in the United States when the US Treasury issued such certificates that could be exchanged for gold. The United States Government first authorized the use of the gold certificates in 1863. On April 5, 1933 the US Government restricted the private gold ownership in the United States and therefore, the gold certificates stopped circulating as money (this restriction was reversed on January 1, 1975). Nowadays, gold certificates are still issued by gold pool programs in Australia and the United States, as well as by banks in Germany, Switzerland and Vietnam.
A $10,000 1934 gold certificate
Sources:
Times Of India
Business Today
Financial Express
NDTV
www.ibnlive.com
Indian Express
Economic Times
Indiatimes.com
finmin.nic.in
LIVEMINT
www.moneylife.in
www.firstpost.com
Economics for Everyone Go(l)d and the World, Indiainfoline
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