Govt mulls IGPC's gold investment product entailing deferred dollar outflow

The finance ministry is considering a scheme for investing in gold without dollar outflow at the time of buying. The scheme is different from all others where price risk is not on the government.

It has been proposed by the India Gold Policy Centre (IGPC), set up by the Indian Institute of Management- Ahmedabad. The proposal, now under consideration, involves buying gold from an international bank dealing in the yellow metal on forward delivery bases such as one-year forward. The transaction should involve an Indian bank, which has ties with an international bank for the bullion business.

At present, investors have only two viable options other than buying physical gold. One is sovereign gold bonds in which gold is not imported, but investors get a return of at least 2.5 per cent every year.

However, the government takes the price risk when bonds are redeemed after the eight-year maturity is over. The other option is gold exchange traded funds, where costs are involved for investors in terms of management fees payable to the fund management company. Regulations imply that the fund management company has to buy equivalent physical gold, which does not help reduce actual gold imports.

Buying gold in futures in commodity derivatives is an alternative, but it has a perpetual cost till it is rolled over beyond maturity of contract and mark-to-market margin risk. The commodity derivatives segment is for hedging price risk more than investment.

The IGPC proposal, conceived by its head Sudheesh Nambiath, states an investor has to pay full money to the bank for booking gold in forward delivery in the international market. If it is for one year, which can be rolled over, forward booking premiums are around 2.5 per cent over the gold price. The investor can benefit from the fact that he/she doesn’t have to pay 10 per cent customs duty and 3 per cent GST for the forward-booking deal till he/she actually converts this to physical gold, which the investor does when he has to convert it for jewellery buying. The proposal was prepared after surveying bankers dealing with bullion locally and internationally.

The buyer bank has to ensure that a transaction is hedged in foreign exchange market (forex) so that if an investor, who has paid the full price of gold and wants to convert to physical gold, the currency risk is not on the bank. Investor, however, has to pay taxes as applicable at the time of delivery. The benefit, often compared to Sovereign Gold Bond (SGB), is that if duty is cut for gold import, as proposed by the NITI Aayog panel, an investor doesn’t suffer a loss. In case of SGB, it is market price even on redemption, and if duty is cut during the investment period, he/se gets less amount.

In case of forward booking, buying bank pays money at the time of conversion, but investor pays money to the bank. Hence, bank gets money for lending it to more profitable avenues. Cost of money for bank is 2.5 per cent for forward premium, hedging cost.

For investors, it is as good as physical gold with no burden of storing it and he/she doesn’t have to pay taxes at the time of buying. This helps policy makers restrict dollar outflow and money bank receives is used for economic activity. Of course, “this is a better option to discourage smuggling, which has been attractive in past few years,” read the IGPC proposal. Smuggled gold is sold in market at 1-2 per cent lower than officially imported gold, and gives rise to black economy and illicit activities.
Key Benefits
  • Illegal gold import in India is 120-150 tonnes per annum
  • Gold import bill has varied between $30 and $34 bn a year since past few years
  • There is a need to reduce $8-10 bn worth of gold import, which is for investment purpose
  • The proposed scheme is without dollar outflow
  • If investors roll over or book profit, no dollar moves out
  • Banks should allow the investment under the scheme as collateral for borrowings

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