The Indian Government has released its Draft Gold Monetization Scheme for comment, which builds
on the earlier WGC & FICCI’s Why
India needs a gold policy proposal. At this early stage it seems “likely
fail in its current form as it does not address some key concerns for banks
and consumers”, according to Reuters.
Whilst it may be news to Zero Hedge that gold pays interest (see In India, Gold Is Not Only Money But Now
Pays Interest) this is not something new for India which has always had a
gold borrowing and lending market although at the retail level it has not
worked so well, with previous schemes obtaining less than 50 tonnes.
Positives for the current proposal are a low 30 gram (approx. 1 ounce)
minimum deposit, a very transparent deposit and assaying process, and
exemptions from Capital Gains Tax, Wealth Tax and Income Tax.
The main problem seems to be that banks will need to offer interest rates
of 3% to 4% to make it attractive to investors but when those banks can
import gold on consignment from western banks at rates lower than that, then “the
government would have to give subsidies to encourage their [Indian
banks] participation”.
Another issue is that “there is no guarantee that tax sleuths will not
come calling hot on deposit, asking for the source” of funds that
purchased the gold, as First Post notes. In addition, they note that the need to
melt the jewellery “is abshagun, inauspicious and a strict no-no”.
The melting issue comes up a lot in the comments to the draft, but one helpful suggestion to “change
the draft to deposit jewellery and get monthly interest on it” seems to
miss the point of the whole scheme, which is for the gold to be used by
jewellers. It also shows the difficultly in marketing this idea when people
can’t see why it makes no commercial sense for a bank to pay interest on
stored jewellery which it cannot use.
It is also a bit of a concern that the Government’s draft says that “banks
may sell the gold to generate foreign currency. The foreign currency thus
generated can then be used for onward lending to exporters / importers”
which is basically saying the bank will go naked short gold (and no, they
couldn’t hedge it as the cost of the hedge would eliminate the profit on
lending cash – hence why the call for subsidies).
However, my main issue with this proposal is that it is a stop gap
solution to the “problem” of gold imports. As Indians are net accumulators of
gold any mobilisation of their existing gold into bank gold savings schemes does
not mean that those people will not buy more gold. All they are
doing is changing the way they hold their existing gold
savings; they will still want to add to their existing
savings (in aggregate). Any mobilised/recycled gold is just sold back to
others who don’t want a bank gold savings scheme – the total amount of
physical gold in the country stays the same, it is just that some are now
holding bank gold savings schemes.
Consider that yearly Indian consumer demand is around 800t and estimated
stocks within India in round numbers are (ignoring Temple Trusts who have
about 2,000t):
Physical Gold held by Indians -> 18,000t
Physical Gold held by Jewellers -> 2,000t
In the banking system, this is the situation:
Bank gold asset (loans) to Indian Jewellers – 2,000t
Bank gold liabilities to Western Banks – 2,000t
If the scheme is so successful that they manage to mobilise 800t a year
then Indian banks won’t have to import gold and can instead sell the
mobilised gold to manufacturers who then transform it and sell it back to
other Indians. After the first year this is what Indians will hold:
Physical Gold held by Indians -> 18,000t
Paper Gold held by Indians -> 800t
Physical Gold held by Jewellers -> 2,000t
In the banking system, this is the situation
Bank gold asset (loans) to Indian Jewellers – 2,000t
Bank gold liabilities to Western Banks – 1,200t
Bank gold liabilities to Indians – 800t
Effectively all that will happen is that the 800t is used to repay the
consignment loans from Western Banks – the Indian Banks use the money from
selling the 800t to the Jewellers to buy London gold which they then
use to repay their Western bank gold loans. After the third year
this would be the situation
Physical Gold held by Indians -> 18,000t
Paper Gold held by Indians -> 2,400t
Physical Gold held by Jewellers -> 2,000t
In the banking system, this is the situation
Bank gold asset (loans) to Indian Jewellers – 2,000t
Physical Gold held by Banks-> 400t
Bank gold liabilities to Indians – 2,400t
Now you may ask why does the bank have 400t of physical? By the end of the
second year, the Indian Banks only have 400t worth of gold loans left, so
when they sell the 800t to the Jewellers that year and buy 800t (which
they have to otherwise they would be going naked short and thus pure
speculating on the Indian gold price falling) it only has 400t of loans to
repay, leaving it with 400t left over. Note that as Indians are not net
sellers (in aggregate) the banks’ only option is to buy gold overseas, but in
doing so they send currency out of the country, which is what the Government
is trying to prevent.
In the 4th and subsequent years, there is no more demand to borrow the
800t of gold being deposited into the scheme – the jewellers only need
2,000t. Ultimately, if we remove the banks (who are just intermediaries) out
of the picture what we have is that the gold that is being lent
by some Indians is going to Indians who want to buy it –
there is a mismatch here, one side wants to lend and still own it, whereas
the other wants to own it outright. That cannot be squared with any fancy
financial footwork – no Indian bank is going to go short gold in Indian
dollars.
So gold mobilisation is probably only good for a few years worth of gold
import substitution and thereafter the Indian Government is back to its
“problem”. All this work for a temporary solution. Easier to just talk to the
main temple trusts and get them to fund the local jewellery industry IMO.
