Government’s Gold schemes and whether they are a threat to Gold in Temples

Presenting the Union Budget 2015-16, Finance Minister Mr. Arun Jaitley had announced launching three government schemes aimed at making the yellow metal a more liquid asset, and reducing gold import burden. These schemes were launched formally by Prime Minister Mr. Narendra Modi in the first week of November, to coincide with the Diwali and early wedding season, which is when the gold consumption traditionally hits a peak in India.

Since this launch, there has been widespread speculation about the success of these schemes which have been in force for just over a month. There has also been speculation that these schemes are an attempt by the government to loot Hindu temples, which have big gold assets built traditionally via donations. Is this criticism fair and is it directed on the right grounds?

It is important to understand the motive behind the three gold schemes, because they target different segments and for different reasons. It is also important to understand how these schemes contrast with what already exists in the space of gold asset class today. And finally, it is important to understand the delta benefits (or otherwise) of these new schemes.

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Gold Monetization Scheme

The Gold Monetization Scheme (GMS) is aimed at bringing out the existing stock of gold in India into the open liquid market and persuade existing gold owners to monetize their assets rather than sitting with these stocks waiting for a rainy day to arrive.

India has an estimated 20,000 tonnes of gold stock. A Gold Deposit Scheme has been running since 1999 already, which has managed to bring out only about 15 tonnes of gold thus far. So the odds were always stacked against GMS, and despite some important tweaks made to the 1999 scheme, the first month for GMS has been a washout, with only 1 kg of gold stock being registered under GMS.

The GMS allows any Indian resident individual or trust or other taxpaying entity to deposit their gold at designated bank branches. These banks will have approved Collection and Purity Testing Centers (CPTC) to evaluate the purity of the gold being deposited and completed the associate paperwork. Minimum deposit under GMS is only 30 grams as opposed to the 500 grams originally pegged in the 1999 scheme. The CPTCs will accept only gold bars, not ornaments. Any depositor wanting to deposit ornaments will have to melt those and convert to bars. Once the purity is established, the bank will then issue a certificate, equivalent of a legally binding I Owe You or IOU, to the depositor.

The bank will then decide the interest rate based on the purity and the term of deposit. The depositor can upfront specify the term and how he/she wants to get back the gold – principal and interest – it can be either as Indian Rupees or as gold, but this preference cannot change during the course of the deposit. The depositor can break the deposit pre-mature, but at a small penalty, like it would be for any other term deposit based investment vehicle. The interest is exempted from income, wealth, and capital gains taxes making it further attractive to monetize the gold stock.

The government has specified three distinct terms for these deposits. These are short term (1 to 3 years), medium term (5 to 7 years), and long term (10 to 15 years). The government has proposed an interest rate of 2.25% for the medium term and 2.5% for the long term deposits, though based on the gold quality, the banks can adjust these. These rates are significantly higher than the existing 0.6%-0.75% rates offered under the 1999 scheme. This is a key feature to attract new depositors.

The process is relatively straightforward, except that finding the CPTCs has been a big pain point in the first month. The depositors have found the actual on the ground movement tough, and it has to be an area of improvement if the government wants to ramp up the scheme. However, given the architecture and the general sentimental value Indians associate with gold, a year or so should be given to gauge if the interest rate attractiveness is pulling more depositors or not.

Sovereign Gold Bonds

The Sovereign Gold Bonds (SGB) is aimed at potential new buyers of gold, not the existing holders. Every year India imports around 800 tonnes of gold, which costs valuable foreign exchange, and once imported, most of this gold just sits with the households or trusts as illiquid asset. The gold purchases are for jewelry as well as a pure investment vehicle hedging against inflation. It is this investor segment which the SGB target.

The SGB offers an attractive investment for 5-7 years, where the buyer of the bond will get the appreciation in the gold price plus an interest rate up to 3% for holding the paper till maturity. The maturity value of the bond will be linked to the underlying gold price. These bonds are offered only to resident Indian entities and individuals, capped at 500 grams of investment per year per entity or individual. The government has also promised to announce capital gains benefits on the interest component in the next budget, although as it stands, the interest component is subject to income tax and the price appreciation in gold to capital gains tax.

These bonds can be pledged with the banks for loans thus increasing their liquidity to some extent. The government has also promised to cover the marketing and distribution costs of these bonds, with the government repaying the issuing agency. Over time, these bonds are proposed to be listed on the stock exchanges too – though it will take time to create the right trading structure. But these features will make the SGBs more attractive with respect to open ended gold exchange traded funds (ETFs). In general, the SGBs will have lesser liquidity than ETFs, but higher yield.

Buying these bonds will ensure that the investor gets the exposure to the gold asset class without actually having to buy gold. The government will save on the precious foreign exchange and some of these savings will presumably be passed on to the bond issuers to cover their operational costs.

SGBs are an attractive investment option and in the first offer in November, the government received 63,000 applications worth ₹246 crores – giving a good launch pad to this new instrument.

Indian Gold Coin

The gold coins bought in India are usually from imported from Switzerland and other countries. To create a national gold coin, the government launched these locally minted coins carrying the Ashoka Chakra insignia. The purpose here is to convince a part of the gold buyers to buy locally, thus saving on foreign exchange again. These coins can be minted with the available gold stock, which will presumably increase with the GMS in play. These coins will be sold via the public sector firm MMTC. This scheme is more symbolic, but can make a small impact if GMS picks up. In the best case, India can even export these coins to other countries, though that is not a near or medium term scenario.

Temples bailing out GMS?

In the last few days, there has been intense social media speculation that the government will ask the large temple trusts to bail out GMS by pledging their gold under the scheme. Given that the success of the scheme hinges on big gold stock owners participating, the temples are an interest segment anyway. The speculation of course has been more given the paltry 1 kg deposited thus far.

Before any judgment is made one way or the other, it must be said that the government controlling the temple trusts is outright incorrect. Ideally, temples like other places of worship would be community owned and operated without government intervention. But this is not the case, and it does not seem to be changing anytime soon.

Today, temple trusts have government, trust, and donor representation among others. The government representation for large trusts could be at the level of district magistrate, but for smaller trusts, there are lower level officials involved. The gold stocks which the temples have are still deposited with the banks either to bear nominal or no interest, or just as a safekeeping item. The books are seldom audited or reported properly in many cases, so chances of pilferage remain very high. Basically, the current management structure is not very transparent and it is open to financial abuses.

In this light, the GMS offers a better economic prospect to the temples, if not a better principled stand. Their gold stock – and for large temples, a lot of it is in the form of bars or coins already – does not earn any yield. The trusts can monetize this stock over short to medium duration and get more gold as interest or cash to buy gold at a later point. Since there are varied deposit maturities available, the more skeptical trusts can choose short or medium term maturities to understand how the scheme works.

The deposit will be against an IOU with maturity conditions specified on it. In the worst case, the trusts can get back their deposits before maturity too, if they see a “political risk” involved. However to say that these near-sovereign IOU instruments will be defaulted on is unfair – this mixing of the issues of who controls the temples and how to get better yield from temple assets irrespective of the control is plain fear-mongering.

Of course, a different government can complete revoke this scheme, but just like the 2015 scheme respects the maturity conditions of 1999 one, it is fair to assume that the deposits under the 2015 scheme will also be allowed to run their natural course. The chances of the government “taking away the temple gold by deceit” are overstated and border on paranoia. The fight on temple control is a different one, and by all means, it should be fought tooth and nail.

Are GMS and SGB successful? That’s a question which cannot be answered in 1 month. The Indian media had gone hysterical after the PM launched the Jan Dhan Yojana (JDY) in August 2014, stating that in the first quarter, more than 60% of the accounts were zero balance and there was hardly any usage. Today that number has fallen to under 10%, and the statistics on the RBI website show how the Rupay cards are flourishing covering a large number of small payments every month. And it has only been 15 months since the launch.

Similarly, the success of SGB should be ascertained in a year or so. These bonds will likely do well if the first tranche issuance is any indication. Even if they cut 5% of Indian gold imports each year, that would be a great success on foreign exchange savings. The success of GMS can be gauged again over a longer term period – maybe the next two years. The GMS also needs changes to the way CPTCs are operating, so it is conceivable that the interest levels may pick up once the process of deposit is rationalized. Also, one hopes that the temples will come forward to take the economic advantage of the GMS rather than mixing up genuine control issues with the chance to boosting their asset base

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