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Gold monetization: What it means

Gold monetization: What it means

In his Budget speech, the Finance minister announced proposals to monetize gold. This means, converting the country’s gold holdings into cash to spur spending and investment, and limit the need to import gold.

Two significant schemes were proposed in this respect. The first is the Gold Monetisation Scheme, which would enable depositors, such as households and jewelers, to open metal deposits with banks and place their gold holdings in them. You can also borrow money using these accounts.

The other initiative, a new Sovereign Gold Bond, would enable investors to trade in gold without having to buy it physically. In addition, the introduction of a domestically-made Indian Gold Coin, bearing an Ashoka Chakra was also announced. This could reduce the need for importing gold coins.

Let’s see how these policies might work and what their intended benefits are:

1) Gold deposit scheme: Although the Budget document does not talk about these at length, they are expected to work similarly to bank accounts. People periodically deposit money in their accounts and receive interest from the bank. The bank uses these deposits to make loans to others and receives interest in return. The difference between the interest paid and received is the bank’s income. Similarly, under the scheme, households and jewelers will be able to place their gold holdings in a metal deposit with a bank. The bank will pay interest for this. It will lend this gold to jewelers who require gold for their daily working and receive interest in return. The difference between the two interests will be the bank’s income. You can withdraw your gold if you wish to in times of need.

Advantages of the scheme. The scheme has two-pronged benefits. First, it will reduce the dependence on imported gold. India is the world’s largest consumer of gold but has to import about 97% of its annual gold demand. This is a drain on its forex reserves, and is a key reason why the rupee value falls. On the other hand, there is 20,000 tons of gold that is unproductively stashed away in household lockers, according to the Finance Minister. The scheme intends to circulate this stashed gold in the economy by pulling it out of domestic safes and lending it to those who need it. This will save the country billions of dollars of gold imports annually. Second, stocks of gold jewelry represent enormous personal wealth. However, this wealth is only notional because it doesn’t contribute to growth. It can neither be spent nor invested. The gold deposit scheme can attract deposits worth Rs 1 lakh crore, according to an Economic Times report quoting SBI research. This gold will be converted into cash in the form of interest. Gold owners can then use it for spending and banks for productive lending. Imagine how much growth an extra trillion rupees can generate for the country. Another media report suggest that this scheme can add 2% to the Gross Domestic Product (GDP) – a measure of the economy.

2) Sovereign Gold Bond: The gold bond will work just like a regular coupon bearing bond that the government issues to borrow money for various purposes. The government receives money from investors, who invest in the bond, and pays a fixed periodic interest known as coupon on it. On maturity, it returns the money to the investors. Similarly, in a gold bond, investors, such as households, will be able to lend money to the government by investing in a bond whose price will be based on the price of a fixed quantity of gold. On this, they will periodically receive a coupon (1.5-2% according to estimates). On maturity or sale of the bond, the bond holder will receive an amount equal to the value of the underlying amount of gold as on that date. Therefore, they will get the same return as buying gold bars or coins and selling them later, when their price increases.

Advantage of the scheme: The benefit of this scheme is that it will remove the need to import gold for investment purposes. At present, when people buy gold as an investment, it has to be imported from outside. This leads to an outflow of forex and increases India’s current account deficit – the amount India owes to the world in foreign currency. With the introduction of the bond, the entire transaction will take place in cash, removing the need for buying imported gold.