Towards a sensible gold policy

The industry should not be overregulated in the name of developing it or curbing black money

When it comes to gold, India’s policy-making has been less than sensitive to its ethos and the economy. In 1947, restrictions were imposed on import of gold. Then, private ownership of gold bullion was virtually banned: The Gold Control Act, 1962, recalled all gold loans given by banks and stopped forward trading in the metal. In 1963, the production of gold jewellery above 14 carat fineness was banned. In 1968 came another Gold Control Act, which prohibited citizens from owning gold in the form of bars and coins. This legislation killed the official gold market, and a large unofficial market sprung up dealing in cash only. Gold was smuggled in and sold in the black market. Many jewellers and bullion traders were involved in this, creating a thriving underground market. It is a surprise, then, that such an unrealistic policy persisted for so long. 

The case for restrictions on gold imports has been that valuable foreign exchange is “wasted”.  Restrictions on gold trade are meant to divert household savings from unproductive physical form. A tenuous link is often made between black money and gold. This negative policy in the past failed on all accounts and, in fact, created problems over decades. The negative approach was gradually abandoned, commencing with the repeal of the Gold Control Act in 1990, liberalistion of gold imports in 1997, and removal of restrictions on loans against gold, but the inclination to take a positive approach was lacking till recently. 

Demand for gold

Most of the demand for gold in India originates from women, and this has to be appreciated in the context of unequal property rights for women and men in the country. Traditionally, gold is inherited by women. Women are deprived of their gold by families only under desperate circumstances. Gold provides safety and security for women, and under difficult circumstances, liquidity for the whole family. Gold is a form of collateral, not only for the common man in distress but even for the Reserve Bank of India (RBI) and the Government of India when there is a crisis, as in 1991. 

However, the problem is that the common man seeking to buy or sell gold is not always assured of its quality and often gets cheated. People who buy gold deserve as much consumer protection as buyers of other commodities. 

Positive approach

In 2015, three initiatives were taken: One, a gold monetisation scheme allowed depositors of gold to earn interest on their metal accounts and the jewellers to obtain loans against their metal account. Two, a sovereign gold bond, as an alternative to purchasing metal gold, was issued. The bonds carry a fixed rate of interest, and are also redeemable in cash by the holder based on the value of the gold at the time of redemption. Three, Indian gold coins were launched that provided an assurance of quality to buyers and reduced the demand for coins minted abroad, thus enabling recycling of the gold available within the country.

Illustration by Binay Sinha

In the monetisation scheme, value of the gold is protected and interest is obtained by the depositor, but she has to convert existing jewellery into gold for deposit purposes and, if necessary, will have to convert the gold back into jewellery on maturity of the deposit. If the scheme is made attractive, people may be tempted to buy gold and deposit it in the banks. In that case, import of gold may increase. The banks do not find the scheme attractive because it means extra holding costs if they do not find borrowers for the gold deposited simultaneously. In many ways, the scheme continues to be impractical, except in the case of holders of large quantities such as temples. 

The gold bond is like any other bond issued by the government, except that it is denominated in grams of gold instead of rupees. Such a bond is attractive to those who wish to have the monetary benefit of holding gold without physically holding it. Further, as an asset class, it provides diversification benefit akin to having a foreign currency asset. However, the government will have exposure to gold price risk. The movement in gold prices so far has not been favourable to the government. There is another risk: If the gold bond scheme becomes hugely successful, the government may find its mainstay, namely rupee-denominated instruments, undermined. 

Under the coin scheme, gold coins can be purchased and sold at the prevailing market value. It is certainly attractive for individuals holding savings in the form of physical gold with characteristics of liquidity and authenticity.

The government has also been trying to bring more transparency into gold trade. It made it mandatory for customers to disclose their tax code, or Permanent Account Number, for high-value gold purchases. A circular was issued on tax aspects of gold jewellery holding by households. In July 2017, the Goods and Services Tax on gold was raised to 3 per cent from 1.2 per cent.

The way forward

The NITI Aayog Report in 2018 is a positive policy document on gold. The recommendations are wide ranging and include gold mining, gold refining, hall-marking, exports, digital payments, and new institutional arrangements, viz, the Bullion Exchange of India and the Gold Board of India. What should be the way forward? 

First, we should not commit the mistake of having unfair, insensitive and unrealistic policies as in the past, but we should not go overboard in supporting the gold economy either. Second, the policy should avoid putting requirements and restrictions on millions of households on gold in the guise of curbing a form of black money kept by a few unscrupulous elements. Third, we should be spending taxpayer’s money primarily on consumer protection. Fourth, the experience with various schemes undertaken recently should be reviewed to determine whether the instrument itself is wrong, rather than assume that the instrument or scheme should somehow be made to succeed. Fifth, as gold has the characteristic of a currency globally, the RBI has to play a central role in the gold policy.  At the same time, consumer protection and export promotion should be major concerns for the government. 

Finally, the broad approach to a positive gold policy should recognise gold’s unique character as a reserve asset for central banks and its importance for the domestic economy as well as the external sector. A positive policy approach should certainly recognise the importance of gold in our economy and society, especially for women, but it should not subsidise or overregulate the industry in the guise of developing it or curbing black money.

The writer is a former governor of the Reserve Bank of India