How Modi government hopes to get gold out of your lockers (and make it productive)

All you need to know about Prime Minister Narendra Modi’s latest bid to help people give up their gold for interest.

India’s gold has always been a problem for the government. Indians have always had lots and lots of gold – India is the world’s second-largest importer – but most of it is lying in safes and lockers or inside homes. Prime Minister Narendra Modi on Thursday launched a new scheme, in the latest attempt by Indian government to monetise the immense wealth that has so far remained locked away.

The new scheme, called simply the Gold Deposit Scheme, allows anyone holding more than 30 grammes of gold to deposit it with the government and earn interest at the rate of 2-2.5% per annum.

These interest payments, the government hopes, will lure people to open up their lockers without worrying about having to give up their gold. But will an interest rate of 2.5% be enough to overcome the Indian tendency to hold on to their gold at home, rather than attempting to monetise it?

Why is gold so important anyway?

Gold is a precious semi-solid metal, largely bought in the form of jewellery or gold biscuits as an alternative asset like shares or property. It derives its value both from its rarity as well as its chemical properties, which make it a fairly stable metal to hold over long periods of time without the fear of corrosion.

The metal is highly valued, considered an auspicious gift and used in everything from festivals to weddings, but only traces of gold are available in natural form in the country, and almost all of it has to be imported. It is the second-biggest import item by value, with up to 940 tonnes of gold being imported last year.

From the government’s point of view, this is a loss of foreign exchange with little productive value, since the metal is rarely taken out  of lockers and put into the market, via banks or financial institutions. Indian government has long attempted new schemes to deal with this problem, but few have been successful.

How does the new scheme work?

The gold owner deposits the metal with the government, gets it measured and then is asked for her consent on having it melted and deposited with the government in return for a certificate. This certificate can be used to open an account with the partner banks which will be credited with the weight of the gold.

The interest payment, however, will be made in terms of weight only. For instance, 2.5 gramme of gold will be added each year if a customer deposits 100 grams of gold at an interest rate of 2.5% pa.

What will the government do with all the melted gold?

All the gold collected through deposit centres will be transferred to refineries where it will either be kept in their warehouses or further sent to banks which can use it to further lend or sell to customers.

Hence, banks may be able to sell the gold to customers in international markets and generate foreign exchange or convert into coins to cater to domestic demand for pure gold coins.

Banks may also be allowed to lend this gold to jewellers who will pay interest at a higher rate than what the banks are paying out to customers.

What stands in its way?

There are many who are arguing that while the scheme may prove effective in bringing out the gold reserves kept by people for investment purposes into the market, it may not end up luring households to give up their jewellery for a meagre 2.5% interest.

Indian households often want to preserve their family jewellery, which is why gold loan schemes usually keep them intact. The new scheme, however, requires the gold to be melted even before a customer gets to know how much she will earn in interest.

“Most Indians look at gold linked to tradition and customs, rather than as a mere investment asset,” Dinesh Unnikrishnan wrote in Firstpost. “Parting with their gold ornaments, even the idle ones, is a last resort for her. According to the World Gold Council, more than half of India’s demand for the precious metal is for marriage purposes. It would be unwise to expect households to actively participate in any schemes that involve ‘melting’ the long-preserved jewellery.”

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