LP_Budget-2015_21March2015.indd

BUDGET

2015–16

Economic & Political Weekly

EPW

MARCH 21, 2015 vol l no 12

Gold Monetisation Scheme

for India

Errol D’Souza

Currently India is the largest

consumer and importer of gold

in the world. Monetising the gold

within the country is, therefore,

important for macroeconomic

stability, and requires a credible

scheme for valuing, storing, and

tracking the metal.

old imports contributed nearly

30% of the trade deﬁ cit of India

between 2009–10 and 2012–13.

Faced with this unsustainably high

trade deﬁ cit in 2013 the government im-

posed high excise duties and import

payment restrictions on gold. This had a

limited impact and towards the second

quarter of 2013 after banning the im-

port of gold coins and imposing tight

restrictions on gold bullion imports, the

imports were linked to the level of ex-

ports. The 80:20 rule stipulated that

20% of all gold imported must be ex-

ported before further imports can be

made.

The new regulations resulted

temporarily in imports of gold falling

drastically

even as unofﬁ cial gold con-

tinued to enter the country.

In spite of all the measures put in

place by the government to restrict gold

imports, Indian demand for gold at

842.7 tonnes in 2014 was the highest

in the world, at 26.2% of the world

demand for gold. The gold monetisation

that the Union Budget proposes is there-

fore an important instrument to contain

the impact of high demand for gold on

the economy.

Reﬁ ne Gold in India

An important issue with regard to

import of gold is that gold may be

imported in ﬁ nished form or in the

form of mine doré

that is then reﬁ ned

to produce gold. The share of doré has

been gradually increasing from 0.02%

of gold imports in 2010–11 to 8.54% in

2013–14. The advantage of doré reﬁ ning

over importing ﬁ nished gold is that

the value addition gets done within the

country thereby generating employ-

ment,

saving foreign exchange,

and

generating tax revenues for the govern-

ment as direct taxes are paid on income

from reﬁ ning. Economic policy should

then prefer promotion of the domestic

reﬁ ning industry over imports.

However, over and above these tradi-

tional economic beneﬁ ts there is a core

competence that a reﬁ ning facility

brings that is extremely important to

leverage at this juncture. This is the

ability to assay

metals and the associ-

ated logistics of moving metals in a

secure manner across locations. These

are exactly the competencies that

banks lacked, due to which there was

extremely limited success of erstwhile

schemes to mobilise gold for productive

purposes in the economy. In interviews

with public sector banks we found that

Errol D’Souza (errol@iimahd .ernet.in) teaches

at the Indian Institute of Management,

Ahmedabad.

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MARCH 21, 2015 vol l no 12

EPW

Economic & Political Weekly

the infrastructure for assaying, vaulting,

transport, and associated software to

support such services was lacking.

Assaying Facilities Needed

Since banks deal with currency and

credit and are not accustomed to dealing

with the subtleties of precious metals

they tend to give little attention to the

earlier schemes that were ﬂ oated such as

the Gold Deposit Scheme. Public sector

banks engaged with such schemes more

because there was a request from the

government and even then they resorted

to lumpy transactions such as from tem-

ple trusts rather than engaging with in-

dividuals. Temple trusts for instance ac-

counted for 46% of the Gold Deposit

Scheme at the State Bank of India (SBI).

For a gold mobilisation scheme to be

successful three important considera-

tions must be kept in focus:

• Valuation: Establishing the purity of

the gold in a transparent and efﬁ cient

manner within a deﬁ ned time frame

is essential.

• Storage and Distribution: Well-deve-

loped logistics to prevent fraud, tamper-

ing, and enable inventory tracking.

• End-to-end customised enterprise re-

source planning (ERP) software.

The integrity of the valuation process

is crucial for the success of such a

scheme. An approved assayer who has

credibility and who ascertains the quan-

tity of ﬁ ne gold that is tendered by an

individual is of utmost importance. In

India, traditionally jewellers have been

assaying the jewellery, bars, or coins

that are brought to them. There has been

no standardisation of the testing tools

used, and the accuracy of the scales that

are being used leaves a margin for error.

An important ﬁ rst requirement for a

gold monetisation scheme to work there-

fore is the opening of purity veriﬁ cation

centres in various locations

around India

that can accurately assay the gold that is

brought by individuals who wish to par-

ticipate in the scheme. The ingredients

of a purity veriﬁ cation centre are listed

in Box 1.

The important managerial issue is

about how to organise such purity veriﬁ -

cation centres that are crucial to the

success of a gold monetisation scheme. It

turns out that the Government of India

is fortunate in that it has a joint venture

between the Public Sector Undertaking,

Metals and Minerals Trading Corpora-

tion of India (MMTC), and Produits

Artistiques Métaux Précieux (PAMP SA),

Switzerland, the world’s largest inde-

pendently-owned precious metals reﬁ ner.

MMTC–PAMP India was incorporated in

2008 and has set up the world’s most

advanced gold and silver reﬁ ning and

minting plant

that became fully

operational in end-March 2012. It has a

highly sophisticated laboratory and has

the credentials that will encourage a

customer in any part of the world, let

alone India, to transact in a scheme that

monetises their gold.

MMTC–PAMP has been accredited as a

London Bullion Market Association

(LBMA) good delivery gold reﬁ ner just

two years after the start of production — a

record for any reﬁ nery in the London

market’s history. In its joint venture

PAMP ensures that the MMTC–PAMP labo-

ratory in India functions in compliance

with high standards by training chem-

ists to work in accordance w ith the Swiss

Precious Metals Control Law (LCMP) and

with the directives issued by the Central

Ofﬁ ce for Precious Metals Control in

Bern (BCMP). Its state of the art assay

laboratory is equipped with services

such as the ICP,

Spark Spectrometer,

and precise wet lab and quality control

instrumentation, and is manned by ex-

perienced Chemistry Masters trained

extensively at the PAMP assay laboratory

in Switzerland. MMTC has retail outlets

in all the regions of India as well and it is

most appropriate for the Government of

India that is a co-owner of this world-

class entity to throw its weight behind

MMTC–PAMP to open up purity veriﬁ ca-

tion centres around the country.

After a preliminary assay is carried

out at a purity veriﬁ cation centre,

the depositor should immediately be

credited with a ﬁ ne metal balance in

her bank metal account. In the earlier

system, the depositor had to wait for

90 days to receive a certiﬁ cate of gold

content as the assay was done after the

material reached the India Government

Mint. Under the current recommenda-

tions, the individual can view her

account online and verify the metal

credit that has been uploaded after the

purity has been ascertained. There is

also a simpliﬁ cation of the redemption

procedure from the earlier requirement

of giving a 30-day notice to the bank,

now to the proposed internet-based

platform where the customer will not

be required to give advanced notice.

She may also at redemption make an

online request for a rollover of the

deposit (in tranches of a year) instead

Box 1: Constituents of a Purity Verification Assaying Centre

Objective

The objective of such a centre should be to provide customers with a world class facility for purity

determination in a defined time frame. It should have an online software to post the results of the

assaying and to auto credit metal accounts.

Customer Interaction

A customer is central to the assaying process. There should be facilities to book an appointment slot

online or through mobile apps. The gold material brought by the customer should be verified in the

customer’s presence and the customer should have the ability to witness how the material is being

treated in order to provide a high level of confidence. Finally the entire process of purity determination

should be completed within an hour and the outcome auto-credited online into a customer’s metal

account with a bank.

Equipment

(a) A hand-held X-ray fluorescence (XRF) analyser would conduct a preliminary quick-shot

verification to identify the karat of the gold. If the customer is satisfied with this initial verification

then she can give the go-ahead to proceed.

(b) Accurate weighing in Mettler-Toledo balances to be calibrated daily with check weights.

purity testing. This involves a process that can take up to 15 minutes and minimises the formation

of slag.

(d) Molten metal is then to be poured into specially designed moulds, then cleaned by pickling and

its purity verified by a high performance XRF machine which has the accuracy of +/- 0.1% for

homogenised metal.

Logistics

The centres should be connected with a refinery with a full-fledged logistics department that has

integral insurance cover for metal movement throughout the country.

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of for the delivery of the metal on pay-

ment of a delivery charge.

If redemption of a deposit is to be

made in gold then to make it efﬁ cient for

all parties concerned it would be advisable

to have standardised forms of redemption.

For instance, redemption could be made

in bullion bars of 1 kg, 100 gm, or 50 gm.

For quantities less than 50 gm settle-

ment could be that the depositor is given

delivery in the form of minted coins with

a minimum weight of 1 gm and the bank

purchases any residual quantity below

1 gm from the depositor. Alternatively,

the bank purchases any quantity less

than 50 gm from the depositor.

Transport and Insurance

All back-end logistics (transport of gold,

storage, and insurance) should be

managed by MMTC–PAMP rather than by

banks which do not have the expertise

on this count. The purity veriﬁ cation

centre receives scrap metal that it trans-

fers

to the reﬁ nery which in turn re-

ﬁ nes the metal within a limited period

of, say, seven days. The reﬁ ned metal

can then be transferred and assigned to

the bank loco MMTC–PAMP.

The metal

is now available with the bank for lend-

ing and it can also begin to pay interest

on the corresponding deposit made by

the customer from this time onwards.

This time period of seven days is quicker

than the current 90 days’ time from the

date of deposit before the metal is avail-

able to the bank for lending.

An effective way for the bank to lend

to a jeweller without substantial paper-

work would be for the jeweller to open a

metal account at the bank. The bank

would then credit the metal account of

the jeweller online. The jeweller in turn

would then direct MMTC–PAMP to physi-

cally deliver the metal and incur a delivery

charge from the reﬁ ner for the transport

of the gold. The MMTC–PAMP depository

at the reﬁ nery would at physical deliv-

ery of the gold to the jeweller debit the

bank’s metal account and the bank in

turn would debit the jeweller’s metal sub

account (Figure 1).

At maturity of the metal loan, the settle-

ment can be made in a similar manner.

The jeweller can do one of two things.

Either the jeweller can deliver metal to

the purity veriﬁ cation centre which is

then transferred by MMTC–PAMP to its

depository at which time the bank’s

metal account is credited with the

amount of metal. Alternatively, the

jeweller can pay in currency at the bank.

The bank will simultaneously purchase

the equivalent amount of gold from

MMTC–PAMP, which will then credit the

metal account of the bank. The online

software would record a transaction where

the bank has raised a settlement invoice

on the jeweller and the MMTC–PAMP

INR (Indian Rupee) account would be

simultaneously credited with the total

transaction value (Figure 2).

This simple organisational structure,

whereby the banks handle the currency

side of the transaction, and MMTC–PAMP

provides all the infrastructure related to

the precious metal part of the transaction

allows each side — banks and the reﬁ nery

— to leverage their competencies whilst

providing value to customers in a trans-

parent and credible manner. An Achilles

heel of the earlier Gold Deposit Scheme

was related to the delivery of physical

gold. In the proposed monetisation

scheme, the MMTC–PAMP would be

required to maintain dedicated Brink’s

vaults and storage at various locations.

This would create an all-India loco stock

which would facilitate lending by banks

to jewellers. Since physical gold will

now be transported across locations

there are some minor taxation issues that

need to be addressed by the Ministry

of Finance:

• Since banks will purchase gold to set-

tle gold loans and metal stocks will be

generated at various locations it would

require that depository vaulting services

under the monetisation scheme be ex-

empted from service tax. As a corollary,

redemption of gold deposits will involve

the movement of the precious metal. The

delivery charges for all metal movement

should also be exempt from service tax.

• The purchase of gold by the banks will

depend on its availability which could be

either interstate or within the state. For

interstate purchases Central Sales Tax

(CST) is liable to be levied on the trans-

action and in turn banks will then

charge Value Added Tax (VAT) to the

jeweller. To facilitate movement of the

gold across locations it would be impor-

tant to exempt CST for the purposes of

the monetisation scheme.

• At the time of making a deposit at a

purity veriﬁ cation centre the depositor

will usually not be in a position to pro-

vide evidence that customs duty has

been paid on the gold she is depositing.

A jeweller providing gold scrap for reﬁ n-

ing gives a declaration that customs

duty has been paid failing which there is

Physical Movement

MMTC–PAMP

Depository

Accounting Flows

Figure 1: Lending in the Gold Monetisation Scheme

MMTC–PAMP

Depository

Borrower/

Jeweller

Borrower/

Jeweller

Bank

Debit

Jeweller’s

metal

sub-a/c

Debit Bank’s

metal a/c

Deliver

retail

metal

Figure 2: Redemption in the Gold Monetisation Scheme

Physical Movement

MMTC–PAMP

Depository

Accounting Flows

MMTC–PAMP

Depository

Borrower/

Jeweller

Borrower/

Jeweller

Bank

Credit

Jeweller’s

metal

sub-a/c

Credit Bank’s

metal a/c

Deliver

metal

Deliver

metal

Cash

settlement

Purity

verification

centre

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an excise charge that is incurred. For

households who have gold handed down

for generations or who have purchased it

from small jewellers there will be no

paper trail available as to the customs

payments on the import of the gold.

Hence, gold deposited under a monetisa-

tion scheme should be exempt from the

payment of excise (currently 1%).

Incentives to Monetise Gold

A tension that individuals face in bring-

ing in their gold to a gold monetisation

scheme is the fear of investigation by tax

authorities after subscription to the

scheme. In many families in the country

gold has been part of the family inherit-

ance for generations. Also, in many

instances gold is purchased from unor-

ganised goldsmiths who do not provide

ownership documents or a purchase trail.

Under the current situation banks are

not required to report any deposits in

cash by their customers that are less

than Rs 1 million. The same limit could

be applied for any deposit of gold made

into a gold monetisation scheme. Also

the current minimum cap on gold depos-

its at 500 gm excludes many middle-

income households. The minimum cap

on gold deposits can be reduced to 50

gm. For any deposit of gold below say

500 gm or Rs 1 million worth of gold,

only identity and address proof should

be required. After that know your cus-

tomer (KYC) requirements could be

enhanced to include permanent account

number (PAN). It is important to stress

that KYC requirements should be imple-

mented

so as to improve conﬁ dence in

the system and to introduce transparency.

Such requirements have the advantage

that they make it difﬁ cult to trade in

smuggled gold. The fact that any cus-

tomer must already have a savings

account with the bank and the metal

account is an add-on facility will simplify

KYC documentation.

The taxation system is currently con-

ducive for gold monetisation schemes and

requires no change. Interest earned on

gold deposits are exempt from income

tax as a result of the amendment to

Section 10(15)(vi) of the Income Tax Act

as amended by the Finance Act, 1999.

Finally, a gold deposit is also exempt

from capital gains that arise from trading

or redemption as per Section 2(14)(vi)

of the Income Tax Act as amended

by the Finance Act, 1999. Nomination

facilities for such deposits in individual

or joint names as per depository rules

should be available. Deposits of gold

should also be transferable as per

depository rules.

The returns being offered on gold

deposit schemes have hitherto not been

attractive. SBI from September 2010 has

been offering 0.75% per annum for three

years, and 1% for four to ﬁ ve years with

the interest calculated in gold currency

(XAU)

and payable in equivalent rupees.

It is possible to pay 2% to 3% annual

grammage return that will make the

scheme attractive (Table 1). The minimum

deposit unlike earlier can also be for a

year with multiples of one year exten-

sions in order to provide ﬂ exibility to the

depositor.

The period of deposits that

the SBI offers of three to ﬁ ve years should

be changed to one to seven years. Pre-

mature payment with a penalty after a

lock-in period of one year as currently

operates could be continued. The bank

may also offer a loan facility to the gold

metal depositor higher than the current

60% loan-to-value ratio, since the collat-

eral is gold of veriﬁ ed purity.

The cost of funds for the scheme may

be estimated as shown in Table 1. This

estimate of cost of funds of 4.9% to

6.95% compares favourably with the 8%

to 10% cost of dollar borrowing from ex-

ternal sources.

Our conversations with

jewellers and business groups in the

gold industry indicates that in the ﬁ rst

month of the scheme being put in place,

it would be possible to collect 15 tonnes

of gold with 10 assaying centres set up.

By the end of the ﬁ rst year it would be

possible with extensive marketing of the

scheme to scale this up to 40 tonnes of

gold per month. Additional assaying

centres that may be set up will of course

increase the inﬂ ow of gold that individu-

als wish to monetise. On a conservative

estimate, it would then be possible, by

the end of the ﬁ rst year itself, to have

collected 100 to 150 tonnes of gold from

the scheme. This amounts to 12.1% to

18.2% of the gold imported into the

country in the last year.

To put it in a

different perspective — it amounts to

0.5% to 0.75% of the estimated mini-

mum of 20,000 tonnes of gold lying

unproductive in the country.

The Sovereign Gold Bonds mentioned

in the budget are a costly way of trying

to reduce investor demand for holding

physical gold. To pay at maturity, the fol-

lowing three components will have to be

hedged: the gold price exposure will

have to be hedged with bullion banks, as

will the exchange rate and customs duty

have to be hedged as the return on such

bonds is redeemable in gold. The other

budget announcement of introducing an

India Gold Coin with the Ashoka Chakra

on it is long overdue. Such coins

should provide assurance to a buy-

er that the purity, weight, and

quality of a gold coin is up to inter-

national standards and that means

production by a reﬁ nery which has

the capability to deliver a brand

that is acceptable internationally.

Internationally, gold coins that have

established a brand such as the

South African Kruger gold coin,

the Canadian Maple Leaf, or the

Australian kangaroo gold coin,

have a purity of 24 carat and they

are aesthetically pleasing. The high

growth in the sale of coins through

bank channels (estimated at upwards of

35%) indicates a pent-up demand. The

current market has largely unbranded

coins with uncertain purity, which pre-

vents the recycling of gold in the country.

Besides, coins are a sure way to increase

the number of organised players in the

value chain in India.

Table 1: Cost of Funds for Gold Monetisation Policy

Cost of Assaying:

(a) Purity verification cost: 0.1%–0.2%

(b) Refining cost: 0.5% –0.75%

(d) Refiner administrative

costs (software, insurance,

administration): 0.5%–0.75%

Sub-Total 1.6%–2.45%

Cost of banks:

(a) Gold price NIL since no need

hedging cost: to hedge

(b) Operational expenses: 0.3%–0.5%

(d) Risk premiums:

1.0%–1.5%

Sub-Total 3.3% –4.5%

Total Cost 4.9%–6.95%

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Over time, as the programme to bring

in gold into productive use gains visibil-

ity as well as scale, the amount of gold

brought into circulation would grow

and this would have favourable implica-

tions for the country’s current account

and balance of payments at the macro-

economic level and also unlock the

value of gold held by individuals at the

microeconomic level.

Notes

1 Gold re-exports as a percentage of total gold

imports have been declining even before the

new regulations, from 41% in 2008–09 to

29.2% in 2011–12.

2 The sharp depreciation of the rupee as well

as the Hindu inauspicious period of shradh,

during July–August, when purchases of valu-

ables are postponed also contributed to the

decline in imports.

3 There were reports that a gold market for 10

tola bars has surfaced again due to the ease

with which they can be concealed (a tola in

India is around 0.375 troy ounces).

4 Doré is an impure alloy of gold and silver pro-

duced at a mine which will be reﬁ ned to high

purity metal. The industry median for gold

doré is 65% gold and 35% silver.

5 It is estimated that direct employment in reﬁ n-

ing is about 300 persons per 100 tonne reﬁ nery

along with an indirect employment of about

200 persons.

6 The average foreign exchange saved is about

$20 million per 100 tonnes.

7 Assaying is the testing of gold, either as ore,

bullion, coin, or jewellery, to determine its

ﬁ neness or purity.

8 In our interaction with jewellers and reﬁ ners we

found that a typical assaying centre could be set

up in an area not exceeding 45 square metres.

9 The reﬁ nery is also one of the largest in Asia

with a reﬁ ning capacity of 100 MT of gold and

600 MT of silver per annum with a provision

for tripling the gold reﬁ ning capacity and more

than doubling the silver reﬁ ning capacity.

10 Inductively Coupled Plasma Spectrometry is

the modern process for assaying gold.

11 The reﬁ ner, MMTC–PAMP must utilise the

services of approved transport providers for

such materials such as Brinks or G4S. Insur-

ance cover for the metal at the purity veriﬁ ca-

tion centre is also a requirement to enter this

business. Typically a reﬁ nery will have insur-

ance cover for the metal at its plant as well as

coverage against terrorist attacks. All metal

movements and the risk associated with them

should be the responsibility of the reﬁ ner,

MMTC–PAMP, and the banks should not have

to bear any risk on this account.

12 In this type of business, loco is the place at

which gold is physically held and to which a

particular price applies.

13 This reduces the maturity mismatch drawback

that banks earlier were faced with.

14 To have compliance with the Prevention of

Money Laundering Act self-attested afﬁ davits

or undertakings could be used as a documenta-

tion simpliﬁ cation measure.

15 This is the price of 1 troy ounce of 9999 pure

gold in monetary units.

16 Since the assayer’s software will provide for

real-time tracking of the quantity of the metal

deposit as well as the duration of the deposit it

will enable banks to manage the maturity

transformation of the gold on deposit in the

form of onward lending.

17 Risk premiums in principle will be minimal as

all dealings are in metal.

18 The cost of dollar borrowing here is taken to be

6% to 7% and includes a 2% to 3% hedging cost.

19 The World Gold Council estimates that 825

tonnes of net import of gold took place in India

in 2013.

20 The All India Gems and Jewellery Trade Feder-

ation estimates the amount of gold lying

unproductive as 25,000 tonnes.