India has historically been a large importer of gold and the total stocks in the country are estimated upwards of 20,000 tonnes. Periodically, when the balance of payments current account deficit (CAD) goes out of control, drastic measures are taken to reduce gold imports.

From 1939 to1992 there was a total ban on the import of gold. When the regime was tightened, illicit imports rose; when the regime was less rigorous illicit imports were lower. After 75 years of trying to use a regime of controls, attempts are now being made to understand consumers’ needs and measures are being introduced to encourage a move away from the physical holding of gold.

The schemes

The three schemes introduced on November 5, 2015 are the Gold Monetisation Scheme (GMS), the Indian Gold Coin Scheme (IGCS), and the Sovereign Gold Bond Scheme (SGBS). For the first time the authorities have attempted to devise schemes that meet the varying needs of consumers.

Gold monetisation: The GMS requires holders of gold in India to deposit their gold with banks after assaying. The gold in jewellery or other form will be melted down and the depositor will get a certificate placing the deposit for varying maturities — short, medium or long. Commentators have rightly pointed out that this scheme is crucial to unearthing gold hoards. While some holders of jewellery may deposit gold, most individuals would not place gold deposits. The individual holder will lose substantial value on melting down the gold and then on maturity converting it back into jewellery. Moreover, if individuals place their gold they would certainly not want to have their gold jewellery melted down for 1-3 years.

It is holders of large quantities such as temples and trusts that have huge stocks of bars who would not mind placing their stocks for longer periods as the rate of interest would be 2.25-2.5 per cent. The viability of the scheme would be on the collected gold being lent out to users of gold who would pay much higher interest rates and reduce imports. The advantage of this scheme is that the agencies (banks/government) would not be exposed to a price risk.

Gold coins: The IGCS would try to divert the demand from imported coins to Indian coins using the GMS for sourcing the gold for producing coins. As such, the success of the IGSC is contingent on the GMS being a success. The agency selling the gold (banks/government) will have to build into their sale price to the agencies minting the coins the projected price of gold at the time of maturity of the deposit.

Gold bonds: The SGBS is the instrument with the greatest potential to persuade the holder of physical gold to switch to a gold price-linked paper instrument. According to the scheme, the investor subscribes to the SGBS in rupees and at the end of eight years gets back the maturity value, in rupees, of the number of grams subscribed at the price prevailing on maturity. There is a proviso for redeeming the bond at the end of five years and there would be a secondary market. The bonds are for subscription only between November 5 and 20, 2015.

The whole process grinds slowly and in a number of bank branches, even in metropolitan areas, application forms are not available. The minimum subscription is 2 grams, the maximum 500 grams. The government has indicated that it is targeting to mobilise a total of Rs ₹15,000 crore and could close the issue of the bond even earlier than November 20. The scheme is really good and in the longer run could wean off Indian holders of physical gold to holding gold paper.

Attending to the glitches

There are, however, some glitches in the scheme that need immediate attention. First, even during this short period of November 5 to 20, the subscription price which, initially, would be ₹2,684 per gram, would change each week. With the subscription price fluctuating from week to week, bank delays and investors needing time to understand this instrument, subscriptions during this period would be meagre. This should not be interpreted as a failure of the scheme

Secondly, for SGBS, there should be a clear arrangement at the inception as to how the gold price exposure would be covered. There could be two alternatives: (i) The government would need to buy a gold option but one wonders if such cover is available for eight years. (ii) The government could build a gold price redemption reserve where it would put in an amount equivalent to the difference between the 2.75 per cent interest on the SGBS and the eight-year yield on government bonds. The second option appears to be more feasible.

Thirdly, the government should, by an early date, announce that in view of the logistics of making the scheme available over a wide geographical area, the period of the bond could be extended or preferably put on tap with a proviso that the government could close subscription at any time.

Venkitaramanan bonds

Most investors need protection if the gold price goes up relative to other instruments and a secular fall in the gold price is unlikely.

The SGBS is a path-breaking instrument. When S Venkitaramanan was governor of the Reserve Bank of India, he had mooted this instrument in 1991-92 and it was announced in the Budget of February 1992 that a Gold Bank would be set up — the reversal of this decision is a sad historical saga. It would be fitting if, in popular parlance, the SGBS is labelled the ‘Venkitaramanan Bonds’.

The writer is a Mumbai-based economist