To reduce pressure on gold imports, the government’s gold monetisation scheme will form a chain network wherein the metal deposited by consumers can be used by banks for further investments and foreign trade.
VK Sharma, former ED of Reserve Bank of India (RBI) says the scheme will not work as at some point banks will have to import gold to give it back to the customer, which counters the basis of this policy.
However, Soumya Kanti Ghosh, Chief Economic Advisor at State Bank of India (SBI) says the scheme could work if more incentives are given to the banks.
“Banks do not find it attractive as of now. As a sweetener, they would like to use a part of the gold for cash reserve ratio. But for RBI, CRR is a way to control inflation,” Ghosh said.
Commenting on the exchange-traded funds (ETF) scheme, Sharma says the government is going to be short, adding that “If the government hedges its exposure by buying physical gold metal, then instead of individuals buying gold from the market, it is a consolidated demand coming from the government going to the same market.”
In ETF, bonds will be issued in terms of grams of gold and will be linked to the price of gold in denominations of 2, 5 and 10 grams.
The demand in ETF will also have to be met by gold imports, he adds.
Below is the transcript of the interview with CNBC-TV18.
Q: For the country, these gold monetisation schemes were first conceived when we had that 800-1000 ton import of gold in the years 2012-2013. Do you think that because of this the country will have lesser problems of gold import?
Sharma: No, I think I do not agree with that. The thing is that, basically in the context of the gold monetisation scheme, there are five things that the draftscheme has proposed. One is use of mobilised gold deposits by banks for buying foreign exchange and making loans to exporters and importers.
Q: Let us consider that first. Do you think it's a good idea for banks to keep that gold, buy foreign exchange against it and then lend it as loans?
Sharma: No. The draft scheme says buying foreign exchange for lending to importers and exporters; this is not done. Banks are typically in the business of lending what they borrow. If they borrow Rupee deposits, they lend Rupees. If they borrow dollars, they lend dollars. If they borrow pounds, they lend pounds. So what I am saying is that it will create a huge market price risk.
Suppose the banks were to convert their deposits, which are around 100 lakh crore now. If they were to use that buying foreign exchange, then they will be exposed to the risk of the rupee appreciating.
They will have to buy back, because when the exporters and importers re-pay back their foreign currency loans, what they are going to do is they use back the foreign currency loans to buy back the rupee. And suppose the rupee appreciates, they are exposed to huge risks. The same thing applies to gold.
Q: Fair point, sir. Let me get the counter from Soumya and then come back to you on whether it would be a good idea to just use it as a loan for gold jewellers. Soumya, would you agree that using gold through this deposit scheme to convert to foreign exchange and give it as loans as a good idea or a bad idea?
Ghosh: See here there is one point. If the banks are in the business of gold monetization, they need to have an alternative source for deployment. And if that has to be considered, the best option is to use it as metal gold loans, because otherwise the margin in this business is too small.
Given the fact that the return on the gold deposits, fixed in terms of gold, cannot be maybe more than 1-1.2%; from that point of view, extending to metal gold loans could givethem some amount of margins and flexibility in terms of conducting a profitable proposition.
Q: What's the take on that Mr Sharma? Let us assume that the final scheme does not allow banks to take foreign exchange loans or currency positions against the gold, but only allows them to take gold deposits and loan it to someone else. Would that be a good idea?
Sharma: The main idea is to reduce gold imports. Now how will it not work? Once the metal loans are made by banks from the gold mobilised by them as deposits to jewelers; Jewellers are going to be the constituency, in terms of the users of those gold deposits.
When they borrow gold, they have to repay in gold only, which means that what happens is that they have to repay the gold borrower. That means they have to buy it back from the market. And recycled gold is roughly about 10 percent of the total gold demand in the country, which means anything above that is going to have to be imported as it is being done now. So it will not lead to a reduction in gold imports.
Q: Soumya, what is your take? Do you agree with what Mr Sharma is saying that ultimately somebody is going to import the gold to pay back to the banks?
Ghosh: Right now, we import around 700-800 million of gold imports. The purpose of this scheme in the first year is to get to 50 tonnes which is around 12,000 crore which needs to be mobilised through the gold imports. It is a business proposition. If you are mobilising gold and you have to promise a return to the depositors, you need some alternative sources.
Those alternative sources need to come from some deployment opportunities or you give banks an additional option like a Cash Reserve Ratio (CRR) waiver on this gold scheme, so that then the bank can actually reap the benefit.
Otherwise, what is going to happen is that the scheme may actually be a non-starter as the banks will not find it profitable to do this business.
Q: Why would it not be if theycharged an adequate interest to the trader?
Ghosh: No, I think that’s not possible. Because already the State Bank also has a scheme similar to that and the returns here cannot be more than 3-6 percent. Generally, the demand for the metal gold is also seasonal. If you are charging them a higher amount and given that the demand is seasonal, then that product is not going to take off. There also the options are limited in terms of charging a higher rate of interest
Q: Well you are saying a sweetener in terms of a CRR. We understand that the Reserve Bank has opposed it saying that the CRR is a monetary policy tool and if you reduce its effectiveness by accounting for some of that in the form of gold, then we will have to increase the reserve requirement, so that it delivers that amount of monetary policy effect. Mr Sharma, do you think the Reserve Bank will oppose using a part of gold as CRR reserves?
Sharma: You see it is a very simple matter. If it is the US, their monetary policy, the legal tender currency is the US dollar. The reserves are prescribed in the currency of the country concerned. Gold is certainly not the legal tender currency of the country called India. So it has to be in Rupees only. Because reserve money creation is in the total control of the central bank, like anywhere else.
The Reserve Bank of India, if it has prescribed currently 4 percent CRR and if suppose 1 percent is allowed as an allowance for meeting the CRR requirement, then the RBI will have to raise automatically. by simple arithmetic, increase the CRR by another 1 percent in order for the monetary policy to remain neutral. That is very important point.
Q: Soumya, is there anything you know? State Bank already has experimented with several gold deposit schemes. Is there anything in the current scheme which can be included or excluded that can make this scheme succeed?
A: In thisscheme, the most important aspect which may make it a success is the amount of gold fixed at around 30gms. Whenever you fix the lower amount of gold that means more people
will come out and deposit gold.
Currently, the scheme we have, the amount of gold deposit is on the higher side. So, that’s a positive aspect of this scheme. But again the point is that there has to be some amount of profitable deployment. Otherwise as a business proposition it may a look a little bit difficult on the part of the banks.
Q: Clearly both of you have identified reasons why it will not succeed. So no for the gold monetisation scheme as far as the draft is indicating Mr Sharma?
Sharma: Absolutely. It is not worth it.
Q: Soumya your final thoughts?
Ghosh: No, I think that the scheme actually could work if we just tweak it a bit. Just to harp on that point that the Central bank of Turkey has an option whereby they have a reserve option co-efficient where the CRR is imposed on the amount of gold deposits.
Here, a dual CRR could be imposed. As rightly pointed out that could be a higher CRR and the Central Bank’s justification of not giving CRR has actually valid points because de facto if you are allowing CRR on gold deposits, that means you are in an open capital account.
From that point of view, it is completely justified. But from the operational and business perspective, if a CRR is not allowed that will not bring down the cost of funds. Hence, that could act against the scheme from the beginning.
Q: What do you think, Mr Mashruwala?
Mashruwala: If your gold coins and jewellery is lying idle, at east gold coins should go into this scheme, even though the returns are fairly less, because instead of gold lying in locker, it makes sense it goes here and whatever returns you get are going to be in form of gold. So, there is still some kind of appreciation that is coming.
When it comes to gold in jewellery; that iswhere I have a little bit of reluctance because I would not encourage people to melt their jewellery unless they are going to eventually need to melt it. So, these days I hear a lot of women saying they are not interested in gold jewellery or they have inherited it from their parents, from their grandparents. If they are going to eventually melt it and convert it into gold, then rather do it now and take advantage of the scheme.
But if you are going to continue holding onto the jewellery and use to for family functions, marriage, etc, then do not melt and do not go an put it in the scheme.
Q: Mr Sharma, what is your sense? Will the gold bond scheme make any sense for the country in terms of reducing the demand for gold?
Sharma: The underlying premise of this scheme is that the government will issue, and they have set that in the draft scheme also, which was not clear earlier - that they are not going to hedge. That means they are going to be short. They will issue the sovereign gold bond scheme and will redeem it at the going price at the time of redemption, that is, 5 years from now.
What happens is that the most conservative prudent scenario would be to assume the worst case situation. Gold has gone all over the place the last 20-30 years. Earlier, the peak was USD 850 in the late 1970's; it came down in the late 1990s - around 1999, it was USD 250. From there, there has been no looking back and it has gone as high as USD 1,900 per ounce till September 2011. So that means gold is trading at around USD 1,170-1,180 per ounce.
The government has assumed the worst case scenario. Risk management is about also looking at the possibility that gold prices could go down. Then the government not only makes money on that. Risk management is about looking at the worst case scenario. Gold can go from here USD 1,180 to USD 1,900-2,000 which means 65 percent appreciation. With a 1,000 tonne of gold assuming, loss will be around Rs one and halflakh crore.
Q: Mr Sharma, my question is what if the government hedged? Then does it make sense?
Sharma: No, if the government hedges its exposure, which the government has said in the case of this draft scheme that they will not; then what happens is that it will come to the same thing. Ultimately, the government hedges by buying physical gold metal. Instead of individuals buying gold from the market, it is a consolidated demand coming from the government going to the same market. Again, it will have to be met by imports only. There is no reduction in gold imports.
Q: Soumya, your take on the sovereign gold bond scheme?
Ghosh: I think, as far as the sovereign gold bond scheme is concerned a couple of points which could make it attractive to the end user. The first thing is that the, as we have rightly mentioned is the hedging point and as the government has rightly said they are not going to hedge. Regarding hedging or not hedging over here, I think the best option for the government is to go for a short tenure. If it is a short tenure, in this case the cost of hedging, given that we are now in the commodity cycle where the prices have been declining, could be minimised. That is point number one.
The other point which the government may have to consider is price fluctuations. The amount of this government bond will also come under this government borrowing programme. I think they are estimating around Rs 12,000 crore. In case prices fluctuate on the upper side, then it could be a little difficult because of the borrowing programme.
The final thing is that the government could actually look into this and make it, in terms of the retail investors, a little more attractive by looking at the smaller centres, whereby it could be a profitable proposition.
Q: Soumya, the government can do much better than the gold ETF. The ETF was doing the same thing. Instead of buying gold for investment purposes, buy the ETF. Why should thegovernment do it better?
Ghosh: No, I agree with your point. But the success of the gold sovereign bond is actually how combine it with the gold monetisation scheme. These two schemes are going to run concurrently. If they run concurrently, then the success of schemes could actually complement each other. In isolation, it may look a little difficult in terms of the different issues like hedging, operational cost, how do you market it to the retail investors, the cost of that and all those things. The idea is to run them together, so they can complement each other.
Q: Okay. Mr Sharma, last word from you. Your comment on the two schemes, if they were launched together.
Sharma: No, it is not the question of the two schemes been launched together. There is no connection between the two. We have to be very logical. In the case of the sovereign gold bond scheme, as I have said before, there are two scenarios. One is, hedging of the short exposure of the government, which they are not hedging. If you do not hedge it, as you rightly said it is like gold ETF. Even with gold ETF, there is no reduction in the gold demand. That objective is not achieved.
If it is not hedged, then you are exposed to huge risk. The government proposed a scheme of Rs 13,500 crore issues of the sovereign bonds, which amounts to about 50 tonnes. Even on that the worst case scenario, we have assumed of the price going from here after 5 years from USD 1,170 to USD 1,920 then with the 65 percent appreciation and on 13,500 crore, it comes to about 10,125 crore including the interest to be paid.
That means it is 75 percent of your gold bond issuance. Is it worth that 75 percent you lose to save imports of 50 tonnes, which is just 3.75 percent of last year’s 32 tonnes. We imported, from the 1,332 tonnes we were importing last year so this amount saved is 3.75 percent. What is the trade off? The trade off is the government might, in the worst case, lose 10,000 crore onborrowing of about 13,500 crore. That is 75 percent you are losing.