India’s love for gold is proving to be a major factor in channeling household savings for productive investments as well as in curbing trade deficit that arises from gold imports. The government is trying in various ways to curb gold demand in the country, which if it works, will be good for the economy and in turn will benefit investors who have exposure to equity and other financial assets.
India is amongst the world’s biggest gold consumers with China and the US. China and India together consume 60% of global gold. The major consumption of gold in India comes from Jewellery and Investment. India’s total demand for gold in calendar year 2014 stood at 930.1 tonnes, Jewellery comprises of 79% of total demand whereas the demand for investment was 19% while Industries account for 9% of total demand.
India’s jewellery gold demand for 2014 hit a record high of 662 tonne despite restrictions put in place by the government in order to curb the demand. The major chunk of jewellery demand came in the fourth quarter of 2014 during October, the Diwali festival and in November, the wedding season in the country. In contrast the demand for gold investments fell by 50% to five year low levels of 180.6 tonnes.
Gold import is always a problem for India as it is amongst the top import items for the country along with crude oil and this negatively impacts the trade deficit and leads to the widening of the Current Account Deficit. India has seen the repercussions of wide Current Account Deficit in 2013, which was led by the huge import of gold at a time when inflation in India was touching highs leading to the INR depreciating to all time lows against the USD.
In order to settle the issue of gold imports, Finance Minister Arun Jaitely in his budget speech for 2015-16, proposed a gold deposit scheme, issue of sovereign gold bonds and issue of Indian gold coins, which will have the Ashoka Chakra, in order to monetize the gold in the country estimated to be worth around 20,000 tonnes that is unproductively stashed away in lockers and is never traded or monetised.
The Gold Deposit Scheme will have households and jewellers deposit their physical gold holding with banks, which will pay interest to the depositors. The bank will subsequently lend gold to jewellers who require gold for their daily working and banks will receive interest in return.
This scheme to a large extent will reduce country’s dependence on imported gold, which will help contain the trade deficit. It will also let gold circulate in the economy in spite of being unproductively stashed away in lockers. The interest received in cash by the depositor can be used for spending.
Sovereign Gold Bond (SGB) is similar to the normal coupon bearing bond where government issues bonds to borrow money from public and institutions and in turn pays the coupon. Similarly in the gold bond, the investor will lend money to the government by investing in a bond whose price will be linked to the market value of gold. The investment in the gold bond will yield interest to investor who will receive the interest on periodic basis and on maturity the bond holder will receive an amount that will be equal to the value of the underlying amount of gold as on the maturity date. Investors can get exposure to gold without actually holding physical gold in the form of bars or coins.
Government and RBI did impose restrictions on gold imports in 2013 but that was only a temporary adhoc measure to prevent depreciation of the INR. The gold monetization scheme is a longer term measure to bring down gold demand. As per State Bank of India’s economic research department GDS (Gold Deposit Scheme) will be able to attract Rs 1 trillion worth of deposits.