Note on Policy for Gold
This note is based on the attached paper
Background:
- The Indian economy is currently under stress on the external front due to declining inflow of foreign investment and rising trade and current account deficits. It is equally stressed on the domestic front with loss of growth momentum and confidence. It is therefore direly in need of a powerful stimulus to regain confidence and growth.
- The government has to search for and unleash domestic reserve energies to stimulate the economy. It needs some unconventional thinking to uncover the hidden reserve energy in the Indian economy.
- Gold is one such reserve whose potential has not been fully explored, particularly in recent times. Gold has four distinct attributes. One, it is a valuable family asset; two, it is a globally tradeable valued asset; three, it is an invaluable forex asset that can strengthen the weak external side of India; and four, it represents investible savings for domestic economy.
- The gold stock that Indians possess is estimated at between $1 trillion (18,000 tons) and $2.3 trillion (40,000 tons). But this is the asset of the people, and not of the Indian State. Globally, governments have nationalised and confiscated gold and turned what was essentially people's asset into State asset. But in India, such a step was never thought of even by colonialists nor considered feasible in free India even when gold control regime was in vogue. It is wise to presume that, given the deep attachment of the Indian people to gold, it will ever remain largely a private asset.
- Out of the 18,000-40,000 tons of gold stock with families, an estimated 3,000-8,000 tons of gold stock is held by Indians as investment (other than jewellery). This hidden asset is $200-billion subterranean reserve energy of the Indian economy. Being a forex asset, it can be used by the Government to stem the external stress and also reboot the hanging domestic growth, as it has the potential to release equal amount of investible resources for domestic economy.
- However, these twin objectives can be achieved only if the idle gold is transformed into strategic forex asset and active capital, as suggested in this note
- Galloping gold imports into India in recent times has added to the stress on the balance of payments with almost half of our current account deficit being attributed to gold imports. A prime reason for the loss of confidence is the vulnerable external sector weakened by high trade and current account deficits, and financed largely by hot money.
- The government has to live with gold and its imports owing to the Indian citizens’ mass loyalty to gold. The fact that 70% of the gold stock in India is in rural areas bears testimony to this fact.
- Even globally, things have drastically changed in recent times. The view that the US Dollar is more valuable than gold which became the founding premise of the post-Breton Woods financial system, is being seriously questioned by the unstoppable rise in gold prices. More serious questions are being raised about the viability of modern economic theories in the wake of the financial meltdown. Gold is now back in favour after being discounted for too long in global financial system. Gold has outperformed most modern financial instruments as an economic asset. With the weakening of the modern financial order, even the global financial establishment is evaluating the possibility of making gold the reference point to make the financial system stable.
- Despite importing more than a quarter of the world's gold, India has not been able to influence or control the global gold prices. This is because the Indian government (RBI) does not have a strategic stock of gold which can be both a forex asset as well as buffer stock to supplement domestic supply of gold and reduce dependence on global supplies when gold prices go up. A sizeable buffer stock of gold with the government would enable the government to intervene in the domestic market when global prices heat up, and thus, moderate the global prices and buy gold stocks when the prices are moderate.
- In the past, such interventions didn't work as the RBI did not have a sizeable gold stock. Given that India is the biggest importer of gold, a significant capacity to intervene is necessary for India. Once endowed with adequate strategic gold stock, the Indian government can deal in gold in the world market and buy and sell it to its people – an advantage which most governments in developed countries do not have as, unlike India, other countries do not generate that kind of demand for gold.
- India needs to develop a medium-term and long-term strategy to handle gold imports given that India will always be importing gold in increasing quantities in future, as recent trends have shown.
- The strategy must include four essential steps:
Step I: Build a strategic forex stock of gold which can act as buffer stock as mentioned earlier;
Step II: Aggregate the national buying power by canalising the import of gold through banks which can buy, sell and deal in gold, like in case of forex;
Step III: Influence and moderate world gold prices by Steps I and II above; Step IV: Emerge as a player in the global gold market.
- By this bold policy initiative, India will be able to turn gold into an invaluable asset. Otherwise, the current drift on allowing free import of gold, without leveraging on the huge buying power of India and without building a strategic forex stock of gold which could act as buffer stock, will increasingly erode the balance of payments of India and contribute to the ever widening current account deficit.
- A point which must be noted at this stage is that most of the gold in India is unaccounted – either bought by people with unaccounted money or by people who are in rural areas and not reached by taxation. Therefore, any scheme to build a strategic buffer gold stock will have to factor this significant fact.
- To summarise:
a) Indian households are now estimated to hold between 18,000 to 40,000 tons of gold – 3,800-8000 tons as investments, and the rest as jewellery. Most of this is undeclared and funded by unaccounted money, or acquired through contraband imports in the past. This is the principal reason for the lack of official data on gold holdings in India, despite gold control laws.
b) 70% of the total gold in India is held by Indians in rural areas. Indians have accumulated huge gold stocks and continue to add to it.
c) Gold has now scored over modern financial instruments in capital appreciation and is being viewed as a global monetary reference point.
d) India imports almost a third of the gold produced globally, because of which there is a drain on forex of over $40 billion a year now. There has been an increase in gold imports every year– with the current year’s imports almost touching 1,000 tons. This is causing serious balance of payments concerns and India is facing an external risk because of huge trade and current account deficits.
e) The Government cannot consider banning or preventing import of gold owing to the mass loyalty of Indians towards gold.
f) India does not have a strategy to handle the huge and surging import of gold which is, almost singlehandedly, hiking / distorting the global gold market and prices. Ironically, the Indian demand is inflating world gold prices - Indians end up paying those prices, and consequently, India is drained of its forex reserves.
g) Paradoxically, imported gold, unlike other items of imports, is a pure forex asset, but since it is not in government custody, it is out of the balance sheet of RBI – as a result, it is recorded as a drain on foreign exchange reserves, despite being in India and in Indian hands.
h) Despite India being the biggest gold buyer and importer, it has not been able to influence or control the global gold prices because its import is not strategized by a national policy.
i) This paper suggests that the only way for India to handle gold buying by Indians and import of gold is to become a player in the global gold market. For this, the government has to build a strategic stock of gold as part of its forex portfolio. This strategic stock will also act as the buffer stock of gold. This is possible because gold, unlike other assets, is a forex asset.
j) This paper does not suggest that the government buy gold in exchange for its current forex holdings. It suggests that the existing stock of gold in India held as investments should be secured by the government by way of lending of gold by the people through a deposit scheme operated by banks, in the way people deposit their money. The scheme could be supported by government guarantee to return the deposited gold.
k) The gold deposited in banks would be sold to the RBI by banks which will operate the gold deposit scheme with marginal gold holdings and the gold acquired by the RBI thus will become strategic and buffer gold holdings. This will add to India’s forex reserves without dispossessing the depositors of their gold.
l) This will enable India to become a player in the global gold market, supported by nationally augmented strategic buffer gold stock. The scheme, explained here, would also turn gold, which is now an idle family asset, into investible capital, in addition to strategic forex stock of the country.
m) The only way the government can build strategic-buffer stock of gold, which alone will enable India to handle the issue of gold nationally and globally, is to make the people of India – households, investors and the rest including religious institutions – deposit their gold like they deposit their money into bank under the suggested scheme.
- The scheme suggested is explained below in detail:
The Gold Deposit Scheme
The Gold Deposit Scheme is a comprehensive scheme which touches upon the policy of import of gold through canalisation, stocking and sale of gold by designated, well-spread bank branches, at globally competitive rates in India, and provides immunity from gold control regulations for the depositors and also from taxation for the gold deposited into the bank.
Essential Ingredients of the Scheme:
First, the scheme must provide that if the depositors part with their gold, they will get it back as gold. Therefore, it has to be a time-bound gold deposit scheme in banks under State Guarantee which assures that when the deposit matures, an equal quantity of gold would be returned to the depositor. This would mean that the depositors have only lent gold under government guaranteed scheme.
Second, since the purpose of mobilising the deposit is to augment strategic buffer stock of gold with the Reserve Bank, the gold deposited into the banks should be acquired by the RBI under an appropriate policy to be formulated and against bonds to be issued by RBI carrying adequate interest so that the banks get return on the Bonds to pay off interest on gold deposits as well as turn the bonds into liquid resources for deployment for development purposes.
Third, to enable the banks to operate the gold deposit scheme, the banks must be allowed to buy and sell gold in national and global markets under an appropriate import policy which has to be devised. The policy must also provide that the banks may look to the RBI as the lender of last resort in respect of their gold deposit liabilities also. The RBI may also devise policies to sell gold back to the banks when they need for meeting their obligations.
Fourth, the depositors must get some return for depositing the gold in banks, so that they find advantage in parting with their gold for a while to get income on an asset which is otherwise idle.
Fifth, it must be transferable security so that they may use it as collateral or for sale. This will make the gold certificate equal to gold. This will facilitate easy marketability of gold in spot market. The delivery of gold deposit certificates should be regarded as equal to delivery of gold.
Sixth, and the most important point, there must be complete tax immunity for holders of gold who come forward to make the deposit.
Keeping the above points in mind, the following gold deposit scheme is suggested for consideration.
Canalise gold imports, make gold available through banks at globally competitive rates in India:
Gold imports should be canalised only through nationalised banks which will import gold and sell it at CIF rates plus such percentage that gold becomes available to Indians in India at globally competitive rates. This would mean that the Indian gold demand, which is now highly diffused, can be aggregated and cartelised through the banking system. This will enable the banks to acquire skills to deal in gold and to enter into regular contracts for buying and selling gold as part of their banking business, subject to restrictions and guidelines prescribed under the scheme.
Nationalised banks to operate gold deposit accounts:
All nationalised banks shall be allowed to accept deposits of gold, through their designated gold branches which shall have assaying facility, from any Indian citizen under KYC norms.
Gold deposits to bear interest:
The deposits may bear interest, for example, at 1% interest on the market value of gold on the date of the deposit for 3-year deposits; at 2% interest for 6-year deposit; 2.5% for 9-year deposit, 3.0% for a 12 year deposit etc. The return of the deposited gold should be guaranteed by the Government of India and the gold stocks of the RBI must be pledged to support the return of the deposited gold, in case of default by banks.
Depositor not to be asked the source of gold:
The scheme must provide that no depositor would be asked to explain the sources of the acquisition of the gold or the sources of his investment in gold.
RBI to buy 90% of the gold under deposit, gold value becomes domestic capital:
The banks will sell (subject to such conditions as the RBI may impose and over the specified period) 90% of the gold which they have acquired as deposit to the RBI and they will be paid by the RBI in the form of bonds carrying 6% interest or more, as the RBI may decide. These bonds should be considered as a part of the cash reserve of banks. By this process, the RBI will be acquiring gold in return for its bonds with the banks. The interest yielded on the bonds by the banks will not only fund the interest payment on the deposit but also enter into adequate forward cover for the deposit. The banks will also be able to add to their investible resources. This will add to investible domestic capital.
The Effect of the Scheme
Gold with people becomes forex reserve:
One, the gold with the people becomes the forex reserves of India. This will enable the forex reserves to be stable and will strengthen the Indian Rupee which is weak because of the sensitive nature of the forex reserves of India.
Gold so bought becomes strategic reserve:
Two, the gold also becomes the strategic gold reserves of India, which will enable India to use gold both as forex stock as well as supply merchandise.
Gold also becomes the buffer stock for domestic supplies:
Three, it also becomes the buffer stock of gold for the country with which it can handle the global gold market and the supply and price fixation in the market.
Idle asset becomes active capital:
Four, the value of the gold which is idle savings becomes actual, usable savings by the RBI issuing bonds on the basis of which the banks will be able to release credit to the system and also raise credit for deployment.
Gold gets securitised:
Five, the gold deposit certificates, which are equal to gold, becomes securitised which the depositor can use as collateral for drawing credit from the bank or from the market. The depositor can also sell the deposit certificates as equal to gold.
Releases liquidity into the system:
Six, as the gold gathered under the scheme would be sold to the RBI after the Banks keep reserve stocks of 10% or so as required by the RBI, there will be release of liquidity into the system which will add to the investible resources of the economy. The scheme may also provide that depending on the period of the gold deposit to which the liquidity relates to classify the resources as short term, medium term and long term for purposes of facilitating the investment programmes of the banks.
3000-5000 tons of strategic-buffer stock potential to handle global prices:
Given that India has an estimated 3,800-8,000 tons of gold as investment, the RBI may be able to acquire strategic gold reserves of approx. 3,000-5,000 tons. These strategic gold reserves will bring multi-dimensional advantage for India.
When global gold prices are on the higher side, the strategic stocks with the RBI may thus be used as buffer stocks to augment local supplies which will enable India to reduce the dependence and demand on global gold supplies and also tame global gold prices. If India's gold imports go down, the world gold prices will tumble. The RBI/Indian banking system could then enter into buying of gold at lesser rates and augment national gold supplies. Thus, the strategic buffer stock of gold with the RBI will enable India to decisively influence global gold prices.
Potential to ally with China:
Given the fact that India and China consume almost one half of global gold supplies, it is possible and even necessary for India to ally with China with regard to buying gold in the global market.
Acquisition of gold mines abroad:
If India can influence gold prices, India may also acquire gold mines elsewhere in the world to augment supplies for India.
Indian can be a player in the global gold market:
Strategic gold stocks will enable the Indian banks/RBI to be a player in the global gold market. This will also enable India to place itself on par with China, which has its own gold production, and enter into an arrangement with China to tame the global gold prices.
RBI can augment stocks by lease or loan from other central banks:
If India builds sufficient buffer stock of its own gold, the RBI can take gold on loan and lease from other central banks, if required, using forward cover, and use it for its gold supply management. Now the RBI has kept its gold stocks in deposit with the Bank of International Settlement and also lent gold to other banks. The RBI may take gold deposits and also loans, if needed, for meeting the local demand for gold without buying gold, but that would be possible only if the RBI has adequate strategic stock of gold. This will enable the RBI to command a much higher supply of gold to handle the national demand beyond the stocks that it has built up through such efforts. Thus, the capacity to access gold will go up once the nation builds up adequate buffer cum strategic stock of gold.
Tax Immunity for Depositors of Gold
Tax immunity is at the heart of the success of the scheme:
The scheme will succeed only if complete immunity is granted under Income and Wealth Tax laws to the gold deposited with the banking system under the scheme. Tax immunity could also be justified on the ground that on government's own gold control policies, people were, till 1990, forced to rely on smuggled and other contraband gold for their requirements.
Tax immunity should be conditional upon disclosure of gold stocks:
However, the scheme must also make it compulsory for gold depositors to declare their gold holdings in other forms. Appropriate exemption may be given to small holdings, say less than five sovereigns per individual. But declaration should not entail the depositor to any tax or other burden by declaring it. Non-declaration should be viewed seriously with appropriate consequences.
The scheme should be open for 12-15 months:
The gold deposit scheme should be kept open for at least 12 to 15 months for people to convert even their jewellery stocks into gold and deposit it under the scheme. It is in national interest to convert part of the jewellery also into investment gold and in turn into strategic gold stock of India.
Formulation of the detailed scheme would require consultations with the RBI and the different tax departments. So, a multi-disciplinary committee of the various institutions involved may be constituted to finalise the scheme.
All the data to support the facts and figures mentioned in this note are contained in the paper attached.