In today's Finshots, we talk about the Gold Monetisation Scheme and explain why it's failed to fully take off.


The Story

India is obsessed with gold. It’s always been obsessed with gold. The ancient Roman author Pliny the Elder called India the sink of all gold. However, this obsession with gold doesn’t always bode well for us.

You see, India doesn’t mine a lot of gold. Instead, we import it from other countries. As we wrote in one of our issues last year —

You can’t buy gold from foreign countries using rupees. You have to pay for it with the dollar. So when there’s a disproportionate demand for gold, there is a disproportionate demand for the dollar. Everybody rushes to exchange their rupees dumping it like an ex they never wanted to talk to and start courting the dollar. The value of the dollar rises and the value of rupee tumbles. And as the rupee loses its value it becomes more expensive for us to import other stuff, like oil. Unlike Gold, we actually need oil. So, it makes sense for us to cut down on gold imports.

But you can’t force people to stop consuming gold. That won’t work. What you could do however is try and source gold from within i.e. simply mobilize and monetize all the idle gold in this country and get people and institutions to make money off of it, instead of tucking it away in a locker.

So the government launched the Gold Monetisation Scheme back in 2015.

The premise was simple. You go to a bank. You deposit gold. You agree on a time frame and depending on when you’re expecting to redeem your deposit, you’ll be offered interest payments in line with your commitment. It’s like a fixed deposit. The only difference here is that you receive gold on the day of maturity. If you can’t wait till then, you can pay a fine and redeem your gold deposit earlier. But obviously, that’s a sub-optimal solution.

Anyway, once the banks take possession of your gold, they’ll ship it to a Collection and Purity Testing Centre. Once they figure out what it’s worth, they’ll put pen to paper. But here’s where things get interesting. Banks can’t sit on this gold and expect to pay you interest every year. They need to monetise it and put it to good use. So they’ll ship your gold to a refiner. The refiner, in turn, will melt and convert it into standardized gold coins and they’ll ship the gold back to the bank. And herein lies the first problem. Once you deposit jewellery, you’re not going to get it back the same way you last saw it. This isn’t a very appetizing proposition for most Indians since we have deep emotional ties to our jewellery. Think Temples. Hindu temples are believed to harbour a good chunk of the country's private gold reserves. However, melting all this jewellery in a bid to monetise gold would never sit well with donors or devotees and it's a big problem.

Anyway, once banks get their hands on these gold coins, they try and make some money off it by lending it to jewellers. The jeweller borrows this gold by paying interest rates of ~6.0–6.5%. And since banks pay depositors only 2.5% under the Gold Monetization Scheme, there’s definitely some money to be made here.

Unfortunately, it doesn’t always fully cover the logistic expenses of running the scheme. There’s insurance cost, transportation cost, processing fee, and other transaction charges. Think about all the money banks would have to spend in safely moving this gold between purity centres, refiners and the jewellers. It’s a nightmare. Banks could very well deploy their resources elsewhere and extract a better margin. And as such, they don’t really have a lot of incentives to pursue this scheme either.

Which kind of explains why we’ve been able to monetise just 20 tonnes of gold since the scheme launched back in 2015. That’s roughly 3% of India’s annual demand for gold. Not stellar numbers by any stretch of the imagination.

But perhaps the real problem isn’t our obsession with gold. Maybe it's something else altogether.

Indians believe in gold because it’s always served as an effective hedge against inflation. Despite the volatility in price movements, gold has almost consistently kept pace with the basket of goods and services that most Indians consume on a daily basis. It’s also the most accessible investment option available and you certainly don’t need to read offer documents carefully before you invest in gold. It’s gold for Christ's sake. It’s always worth something.

So perhaps the best way to reduce our dependency on imports is to look inwards. Alongside programs like the Gold Monetisation Scheme, we ought to be looking at social protection. If people have better avenues to limit their downside including insurance, fixed deposits, or even a savings account for that matter, maybe people wouldn’t turn to gold as much. Maybe the only way to reduce our dependency on gold is to create more robust dependencies elsewhere.

Until then…

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