COMMENTARY
INTERVIEWS
SPECIALS
CHAT
ARCHIVES

The Rediff Business Special/A N Shanbhag

Scheming to break Indians' bond with gold

According to some reports, India imports more gold than oil.

That sums up the rationale behind the launch of yet another gold deposit scheme. The idea is to mobilise idle gold, channel it as productive savings and at the same time reduce dependence on imported gold.

Under this scheme, selected banks will be permitted to accept gold deposits and in turn issue interest bearing certificates or bonds. On maturity, these can be reclaimed in gold or cash.

So far, the details of the scheme have not been announced. The finance minister has been reticent about his expectations from this scheme.

Unofficially though, it is estimated that the scheme may manage to garner gold worth Rs 50 billion. Although the Reserve Bank of India has not yet announced the interest rate on these bonds, it is expected to be in the region of 2.5 per cent to 3.5 per cent per annum.

It is slated to be an open-ended scheme with tradable debt instruments having a lock-in period of about seven years. Redemption will be in the form of gold or cash at the then prevailing gold prices.

As an incentive for people to dip into their vaults and turn in all the gold that they own, the interest on the bonds is exempt from all the taxes. So, the equivalent tax-free rate of 3.5 per cent per annum, in the 30 per cent tax bracket, will work out at around 5.2 per cent taxable (do not forget the surcharge). No great shakes.

However, there is no wealth tax. This is the best feature. The bond converts an idle consumption asset into a productive one. This exemption is a welcome boon to the holder. So far, the hoarders (sorry, holders) were expected to pay wealth tax after a general threshold of Rs 1.5 million, covering residential houses (one house free from tax), cars, precious metals including jewellery, etc. Over this level, the gold stacked in vaults attracted tax at one per cent, year in, year out.

The gold bonds give an opportunity of saving this tax over and above earning a little interest. Gold bonds also enjoy freedom from capital gains tax. Consequently, any gains from trading or from redemption would not be taxed as capital gains. Add to this the cost of storage and the associated risk. The bonds protect an individual against all these headaches.

Whether the scheme meets with success will be clear once the details are formalised. Crucial will be the initiatives of the state governments pertaining to exemption of movement of gold covered under the scheme from octroi, sales tax, stamp duty and other levies.

It is indeed surprising that the government has decided to launch this scheme while keeping the import duty rate constant. Recently, the import duty on gold has been increased from Rs 250 per ten grams to Rs 400.

Consequently, premium on gold increased from 6.5 per cent to 9.5 per cent over the international price. The inflow of gold through unofficial channels increased as smuggling became lucrative.

If the gold bond scheme picks up, the import of gold will be lower in 1999-2000, as part of the domestic demand will be met through recycling of mobilised gold. If an active domestic market is created and import of gold is curbed, then even the rationale for additional duty on gold imposed disappears.

At first glance, the scheme seems feasible only for importers of raw gold through official channels. Most of the domestically held gold in our country is in the form of jewellery, more often than not handed down the generations.

For starters, there is a tremendous sentimental attachment to these ornaments. I really wonder whether the lure of the small interest would be enough for the owners to turn in their gold. For redemption will be in the form of cash or gold.

The ornamental value of jewellery and the associated making charges would disappear. This is an impediment and remains unaddressed. (The same problem exists for all those consumers who convert their old jewellery into new designs and fashions.)

Secondly, and more importantly, there is no amnesty. In the past, there had been four such schemes. The last one had a built-in amnesty largely due to which around 41 tonnes of gold was collected. Without an amnesty provision, it is difficult to envisage such schemes gaining popularity.

Most people may not have proof of purchase of the jewellery that has been handed down the generations. Few would be willing to risk the taxman knocking at the door and asking all sorts of awkward questions, just to earn some interest on the idle gold.

Just how much gold is there in the homes of 950 million Indians remains a mystery. India is the world's biggest consumer of gold with annual demand estimated at around 500 tonnes.

The RBI estimates the total gold stock in India to be 9,016 tonnes, roughly seven per cent of an estimated world stock of 128,800 tonnes.

Jamal Mecklai, managing director of Mecklai Financial and Commercial Services Limited, said documents in his family archives had led him to believe that India had gold stocks three times larger than official estimates. For a poor country like India, the consumption of gold belies all expectations.

Traditionally, the gold is expected to provide protection against inflation. The price is positively correlated with time. The gold prices moved in a narrow range during the last seven years, the same expected term as that of the gold bonds.

In 1991, the price of ten grams of gold was Rs 3,466. In 1992, it was Rs 4,334; 1993 -- Rs 4,140; 1994 -- Rs 4,598; 1995 -- Rs 4,680; 1996 -- Rs 5,160; 1997 -- Rs 4,725 and in 1998, it was Rs 4,045.

Not all that glittery. Yet, the attraction is so much that the demand has been on the rise year after year. It is obvious that the purchaser is neither worried about the prices nor the holding costs. Possibly, some stronger incentives are required to make the holders part with the gold/jewellery.

Gold is like bearer bonds. The taker is the owner. If a thief takes it away, you will be lucky in the unlikely event of the police nabbing him. However, if your wife takes it away, your investment is a dead loss. These gold bonds are, however, not bearer bonds. If these are lost, the duplicates can be obtained and no one else can encash the same.

If the gold bond succeeds in its objective -- my guess is it won't -- the prices will fall, leading to capital loss instead of any gains. Secondly, this loss would also offset the interest that you would earn on the bonds.

Business News