Buying gold has been a tradition in India for centuries, and so is wearing gold jewellery and gifting it Over the last 10-15 years there has also been a huge increase in buying gold in the form of coins and bars.

There are two reasons for this. First, parents see this as a way of accumulating gold for their children’s marriages.

Second, it is seen as an investment,especially over the last decade when gold has shown low volatility (at least in rupee terms) and has been used as a hedge against inflation.

Indians’ faith in gold has been reinforced by the fact that gold prices in rupee terms are just about 10 per cent lower than their peak values in the domestic market despite depreciation of the rupee as well as the increase in import duties.

Besides, equity markets have been in the 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 is around 20,000 tonnes.

However the actual holding after considering unaccounted imports and ancestral holdings would actually be something between 25,000 to 30,000 tonnes.

The value of this at current prices will be $800 billion (Rs 48 lakh crore) for the official estimation and anywhere between $1-1.25 trillion (Rs 60-75 lakh crore) for the actual holding.

A possible solution

Over the last few months we have seen the Government introduce a large number of measures to restrict gold consumption since its increasing import was believed to be one of the biggest reasons for increase in the current account deficit (CAD).

The Government’s measures to stabilise the rupee have largely focussed on boosting debt inflows, which have to be repaid eventually. The RBI’s liquidity tightening measures have done more harm than good.

The opportunity to raise cheaply-priced sovereign bonds in the second half of 2012 and early 2013 was also not utilised. Raising money at this point of time is not only expensive but also might not receive the requisite demand. Under the circumstances I believe the best solution lies in a ‘Gold Amnesty’ scheme.

There is a huge amount of gold with Indians that has either been bought in cash or was inherited, that has not been declared as official holding.

Gold and land aretwo 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 (Rs 1.2 lakh crore) in order to bring about some stability in the foreign exchange markets.

However, the important thing is to evaluate how the scheme will actually work. In a normal amnesty scheme, undeclared income is converted into white by just paying tax on it. The Gold Amnesty scheme will have to run differently as no one would like to pay upfront tax on the value of the asset they are declaring.

The advantages

I believe that the best way to run this scheme is as follows:

As a first step, holders should declare their gold should to the Government and the Government should, in turn, issue 10-year zero coupon bonds to them.

The yield on these bonds will be around 4 per cent 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 around 6 per cent and as such the 2 per cent gap will take care of the tax that the declarer has not paid on the black money used to buy gold.

As a 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 its foreign exchange reserves and in turn give the equivalent money to the Government.

The other option will be for the RBI to sell this gold in the international market, realise the money in dollars and provide the equivalent rupee amount to the Government.

Any of these options will boost the foreign exchange reserves and stabilise the rupee. Now the question is how much gold the Government will need to get to make a meaningful impact. At current prices one tonne of gold will be approximately $40 million (Rs 240 crore). So 25 tonnes will be required for $1 billion.

The Government needs to target a quantity of 500 tonnes for an amount of $20 billion. This is 2-2.5 per cent of the current holding of gold in India and should be easily possible if the scheme is run well.

The Gold Amnesty scheme has three clear advantages. Unproductive gold will be converted into productive financial assets, the Government will be able to raise cheap long-term money, and foreign exchange reserves will get a leg up. Given that the Government will be able to realise around Rs 1,20,000 crore in 10 years it will also help ease liquidity.

This will provide a significant buffer to the Indian economy till the next government settles down and takes steps to resolve the CADproblem in a more sustainable manner.

(The author is a senior portfolio manager. The views are personal.)

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