Twenty Questions on the Gold Monetisation Scheme

Indians have an insatiable appetite for gold, it seems. Despite prices going through the roof, demand has grown exponentially. By some estimates, private holdings of gold in India exceed 20,000 metric tonnes. Annual imports of gold are estimated to be in the range of 800-1,000 metric tonnes, which accounts for about 1.0-1.5% of GDP. Large and sustained gold imports, are a strain on the external sector's management, particularly when the Indian exports growth is not robust. Indeed not only does the craving for gold, and the imports thereof, have adverse impacts on current account deficits (CAD) and balance of payments (BoP) situation, it also weakens the Indian currency. 

Therefore, the K.U.B. Rao Committee recommended that the strategy to reduce the demand for gold should consist of a combination of demand reduction measures, supply management steps and increased monetisation of idle domestic gold stocks.

Draft Scheme Announcement

So the Finance Minister in the Union Budget of 2015-16 proposed the introduction of a “Gold Monetisation Scheme, [which] will allow the depositors of gold to earn interest...and the jewelers to obtain loans in their metal account. Banks/other dealers would also be able to monetize this gold.”

The draft “Gold Monetisation Scheme (GMS)” has been announced with the objectives of: 

1. Mobilizing the gold held by households and institutions in the country; 
2. Providing a fillip to the gems and jewellery sector in the country by making gold available as raw material on loan from the banks;
3. Reducing reliance on import of gold over time to meet domestic demand.

Gold depositors stand to gain from likely tax exemptions such as such as capital gains tax, wealth tax and income tax under the GMS after due examination. The bank will commit to paying an interest to the customer which will be payable after 30/60 days of opening of the Gold Savings Account. The interest rate to be given is proposed to be left to the banks to decide. The tenure of the deposit will be a minimum of one year and with a roll out in multiples of one year. Like a fixed deposit, breaking of lock-in period will be permissible.

The procedural aspects of the scheme work as follows (refer schematic above):

• Designated Purity Testing Centres (PTC) collect gold from customers, who get issued Gold Deposit Certificates (GDC) against the collected gold. The PTC charges customers a fee for the services rendered.
• The collected gold gets re-assayed and melted into conventional bars and coins.
•  Banks then open Gold Savings Accounts for customers based on the GDC. Customers are paid interest, perhaps tax-free, on the deposited gold;
• The re-assayed gold then is conveyed to Indian jewelers, who are sanctioned gold loans carrying appropriate interest rate. The interest rate charged to such borrowers will have to cover: (a) fees paid to refiners and the purity testing centres; (b) cost and overheads; and, (c) profit margins. Effectively, it is the same as leasing and re-hypothecation.
• Banks can get gold directly from international market on a consignment basis and lend it to the jewellers. 

By utilising this domestic supply, RBI hopes to curb gold imports. This eases the selling pressure on rupee, which boosts its value. Thus, the pros of the Gold Monetisation Scheme are obvious. Nevertheless, the draft has many gaps and lacunae, which are highlighted below.

Purity Verification and Deposit of Gold

• Question 1: Under the draft scheme announced, the customer needs to field “Know Your Customer (KYC)” form for deposit of gold. The information sought must include a declaration of total gold assets owned by the depositor to ensure that the GMS scheme does not serve as a safe harbor for benami assets, money launderers, hawala operators, tax evaders, black money hoarders, etc. PAN/TAN is a must. What customer details are planned to be collected under KYC norms? 

• Question 2: There has to be an image capture and recording process at the purity testing center to ensure that smuggled or contraband gold is not brought into the system surreptitiously. Neither should the PTC function as a fence for stolen or misappropriated property. This is particularly crucial in case a customer turns in bullion. What is the verification process envisaged for ensuring that the gold articles and artifacts turned in at the Purity Testing Centre (PTC) are lawfully, legally owned and possessed?  

• Question 3: The scheme is silent too about whether a “Declaration of Source” on the gold being deposited will be sought from prospective clients. It seems like the scheme is likely to be operationalized with no questions asked on source. No mention is made too on what countermeasures the tax authorities are likely to take against laundered or illegal gold deposits. Is an amnesty programme or a waiver of disclosure part of the monetisation scheme?

• Question 4: The draft GMS document ambiguously states that capital gain tax, wealth tax and income tax exemptions are ‘likely’ to be made available to the depositor. The capital gain, wealth and income tax implications on maturity of deposit must be made amply clear to customers. Are any stratified taxation structures and/or exemption plans envisaged for making the scheme attractive to depositors?

• Question 5: The scheme is also targeted at small, marginal depositors. It is quite possible that some customers, gullible or otherwise, might bring in high-value antique jewelry or gold artifacts to the PTC. What processes are planned to be taken to avoid the melting of high-value gold articles at the PTC? 

• Question 6: The minimum quantity of gold that a customer can bring is proposed to be set at 30 grams. Is the minimum quantity set at 30 grams of pure 24-carat gold?

Opening of Gold Savings Account With Banks

• Question 7: The draft stipulates that depositors must exercise the option of redemption/withdrawal in cash or in gold at the time of opening the gold account with the bank. Such a lock-in option could work to the detriment of either the bank or the investor depending on the movement of gold prices in the market. Can the scheme permit greater flexibility on the timing of the exercise of that option without jeopardizing the interests of the bank or other financial institution taking in the gold deposit?

• Question 8: The draft states that the Gold Savings Accounts will earn interest in gold. Both principal and interest, payable to depositors of gold, will be ‘valued’ in gold. For example, if a customer deposits 100 gm. of gold and gets 1 per cent interest, then, on maturity 101 gm of gold is credited into the account. This calls for a need to protect the interests of depositors who exercise the option of redeeming deposits in cash. Does the scheme guarantee a minimum return on gold savings accounts just in case gold prices were to crash in the international market?

• Question 9: The scheme says that gold saving account will be opened based on the gold deposit certificate (GDC) issued by the PTC. What anti-fraud measures and / or verification mechanisms are planned for ensuring that fake, forged or counterfeit instruments are not deposited?  

• Question 10: It is clearly not enough for the Purity Testing Center (PTC) to confirm the receipt of gold and the validity of the gold deposit certificate (GDC) to the bank. Communication too must flow back to the PTC from the bank accepting the deposit of the GDC to minimize the risk of fraudulent opening of multiple accounts with duplicate, counterfeit gold deposit certificates. Ideally, a depository must be instituted to monitor the dematerialized flow of gold. What are the plans or mechanisms envisaged in this regard?

• Question 11: The draft does not mention any insurance or other means for providing a safety net to depositors of gold. What measures― such as, deposit insurance, sovereign guarantees, underwritten losses, etc.― are planned to safeguard the interests of depositors in case the bank declares insolvency, say, due to scams, non-performing assets, or otherwise?

Transfer of Gold to Refiners

• Question 12: Per the draft scheme, banks pay the refiner for services provided. Needless to say, there is the likelihood of gold purity losses during the refinement process. Who will bear such gold weight losses during purification?

Utilisation of Deposited Gold

• Question 13: The draft mentions that the gold mobilized can be deposited with RBI to meet Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) norms. It is silent on whether the SLR and CRR stipulations apply to the gold deposits― made either in gold-weight terms or rupee-equivalent-value terms― that banks mobilize from customers. Can this be clarified?

• Question 14: The scheme is silent about whether certificates of gold deposited or gold saving account can be used as collateral security. There is no mention of whether nomination, transfer or gift of the certificate of the gold deposited or the gold savings account can be made. Can the position be clarified?

• Question 15: The GMS draft document permits the sale of gold for generation of foreign currency or delivery of gold to domestic commodity exchanges by banks. However, banks and exporters are not permitted to export bullion at present, which perhaps will be allowed to do so in the future. Besides the regulatory controls by RBI over each such transaction, what norms and limits are likely to be imposed on such operations to mitigate market risks?

• Question 16: Suppose the international prices of gold crash or nosedive, say, because of weak demand for the metal or bearish conditions in the commodities market. A bank run or panic could get triggered for premature withdrawal / redemption of gold deposits. What are the precautionary measures envisaged to protect the interests of investors in such scenarios?

• Question 17: On the flip side, if gold prices skyrocket, the yield of gold deposits in rupee-value terms will be much higher, thus leading to significant losses for banks. What is the mechanism envisaged for mitigation of such risk for banks?

• Question 18: The scheme is silent about hedging mechanisms for eliminating price risks of gold collected. What is proposed with regards to tacking such fluctuation in gold prices?

Lending the Gold to Jewellers

• Question 19: The announced GMS draft makes no mention of how interest will be charged on gold loans to jewellers. Since gold deposit accounts earn interest in gold, it is perhaps a safe assumption that gold loans to jewellers will carry interest payable in either gold or equivalent value. Can some light be thrown on this?

• Question 20: The scheme does not reveal much about customs duty component. Suppose a jeweler takes a gold loan and exports gold jewelry, will any duty drawback or exemption be applicable?

Conclusion

On the whole, I am foxed that the attempt is to introduced a radically new scheme. A less risk prone approach would have been to do away with the current mechanism of auctions held by "Gold Loan NBFCs-ND-SI" (Systemically Important Non-Deposit-taking Non-Banking Financial Companies). 

Then, instead, the pledged jewellery of such defaulters could have been mandatorily liquidated through a process of re-assaying and refining. Not only would this system protect customer/borrower interest better, it would also have curbed many malpractices of the "Gold Loan NBFCs-ND-SI". The gold bullion so recovered would surely have reduced the imports burden.

Nevertheless, there is a lack of clarity on several fronts in the draft GMS document. Complete transparency and no ambiguity on the modus operandi is needed; if not, then there is the risk of gold monetisation turning into a Ponzi scheme.