Buying gold has been a tradition in India not only for decades but for centuries. Wearing gold jewellery and gifting the same in marriages is a part of Indian tradition. Over the last 10-15 years there has also been a huge increase in buying of gold in the form of coins and bars for two reasons. The first being that these are being accumulated for future use as parents use their current cash flows to accumulate gold for their children’s marriages. The second has been the investment buying which has been a result of the secular uptrend in the value of gold over the last decade where gold has shown low volatility (at least in rupee terms) and has been used as a hedge against inflation. The fact that gold prices in rupee terms are just about 10% lower than their peak values in the domestic market due to the depreciation of the rupee as well as the increase in import duties has reinforced the belief of Indians in gold given that the equity markets have been in doldrums, real estate has stagnated and become illiquid and fixed income post tax returns are much below inflation.
It is officially estimated that the total stock of gold held by Indians will be in the region of 20,000 Tonnes. However the actual holding after taking into account unaccounted imports, ancestral holdings etc should actually be in the region of 25,000 to 30,000 tonnes. The value of this gold at current prices will be $ 800 billion for the official estimation and anywhere between $ 1-1.25 trillion for the actual holding of gold.
Over the last few months we have seen the government introduce a large number of measures to restrict gold consumption. The increasing import of gold has been talked of as one of the biggest reasons for the increase in the Current Account Deficit which is considered to be the biggest issue facing the Indian economy at this point of time. The financing of the CAD at a time when exports have not picked up despite a significant INR deprecation and also at a time when FDI inflows have come down to a trickle due to policy inertia, slowing growth and lack of faith in the Indian economy has become one of the biggest challenges for policymakers. The rapid decline of the rupee has increased the subsidy burden due to various government subsidies and has a negative impact on inflation with the pass through of imported product prices in rupee terms.
The government has been thinking of various measures to stabilize the rupee, which in the short turn have largely focussed on boosting debt inflows which eventually have to be repaid. The liquidity tightening measures of the RBI have done more harm than good. The opportunity to raise a cheaply prices Sovereign bond issue in the second half of 2012 & early 2013 was also not utilized & raising such money at this point of time is not only expensive but also might not yield the requisite demand. Under the circumstances I believe that the best solution lies in a “GOLD AMNESTY SCHEME”.
There is a huge amount of gold which is there with Indians that has either been bought in cash or is there as ancestral holding which has not been declared as official holding. Gold and Land have been the two main assets that have been used to deploy unaccounted cash in India. The government needs to boost its foreign exchange reserves by around $ 20 billion in order to bring about some stability in the foreign exchange markets. However the important thing is to evaluate how the Gold Amnesty scheme will actually work. Unlike a normal amnesty scheme where the undeclared income is converted into white by just paying tax on it the gold amnesty scheme will have to run differently as no one will like to pay upfront tax on the value of the asset that they are declaring.
I believe that the best way to run this scheme will be as follows
– As the first step the gold will be declared by the holders to the government and the government will in turn issue 10 year zero coupon bonds to the people who declare the gold. The yield on these bonds will be in the region of 4% and on redemption the amount that is paid will not be taxed in the hands of the holder. The post tax yield on ordinary 10 year bonds are in the region of 6% and as such the 2% gap will take care of the tax that the declarer has not paid on the black money used to buy gold.
– At the second step the government will have to decide what to do with the gold that it has got. One option would be to sell it to the RBI which will then add this gold to the foreign exchange reserves and in turn given the equivalent money to the government.
– The other option will be for the RBI to sell this gold in the international market, realize the money in USD and provide the equivalent INR amount to the government.
– The last and the best option is for the gold that is bought via the amnesty scheme to be made available to domestic gold refiners. This will cut imports and will have the lowest money leakage.
Any of these options will boost the Foreign Exchange reserves and stabilize the rupee. Now the question is how much gold will the government need to get to make a meaningful impact. At current prices one tonne of gold will be approximately $ 40 million. As such 25 tonnes will be required for $ 1 billion. As such the government needs to target a quantity of 500 tonnes for an amount of $ 20 billion. This is 2-2.5% of the current holding of gold in India and should be easily possible if the scheme is run well.
The GOLD AMNESTY SCHEME will kill three birds with one stone. Unproductive gold in the hands of Indian’s will be converted into a productive financial asset, the government will be able to raise cheap long term money and the Foreign Exchange reserves will get a strong leg up. Given that the government will be able to realize around Rs 1, 20,000 Cr in 10 year money it will also remove crowding out from the economy. This will give a significant leeway for the Indian Economy till the time the next government settles down and takes steps to resolve that Current Account Deficit problem in a more sustainable manner.