All That Glitters Is Paper Gold

Mumbai-India (Nov 8)  Retail investors can be somewhat happy with the three gold schemes launched by Prime Minister Narendra Modi on Thursday. The three - a gold monetisation scheme, gold bond scheme and gold coin scheme - intend to ensure a citizen's love for physical gold is satisfied with paper gold.

 There are several good things going for the schemes. However, experts and sector players believe, to attract retail investors or depositers into these, the government and especially banks will have to aggressively back the schemes. Chirag Mehta, senior fund manager, alternative investments, Quantum Asset Management Company, observes: "We are trying to draw a leaf out of Turkey's books, where it has been a huge success. However, the important difference is in the approach."

 In Turkey, the depositor of gold walks into a bank branch with which he has been dealing for years and his other savings are already there. Therefore, the depositor has the much-needed trust and confidence in the institution where he's going to deposit his gold. Here, however, the customer will have to walk into an unknown collection centre to verify and deposit his gold. In the initial phase, holders of gold will not find it easy to part with their holdings in a deal with an unknown entity.

 Another important thing retail investors would want is clarity over taxation. As Deloitte Haskins and Sells' senior director Alok Agarwal says: "The government's press release still does not give enough clarity on this, something every retail investor will be looking at. The good news is that the government has indicated there will be no income tax (I-T) on the earnings and no capital gains tax on appreciation in the value of gold deposited."

 That said, the schemes have pluses:

Gold monetisation

 You will be paid an annual interest of 2.25 per cent and 2.5 per cent for a tenure of five to seven years and 12-15 years, respectively. Banks are yet to give rates for schemes of one to three years. Premature withdrawal is allowed but after a minimum lock-in and with a yet-to-be-decided penalty. By reducing the minimum deposit from 500g earlier to 30g, the entry barrier has been substantially lifted. Agarwal says it is a good scheme for people who are holding on to their gold for, say, their daughter's marriage 15 years later.

Issues: However, experts say there could be issues with jewellery, because of the problem of under-caratage in gold. "When the depositor goes and his jewellery, marked 22-carat, is found much lower in purity and fetches him a lower than expected value, there is bound to be conflict," says one.

 The interest rate is also not so attractive. The country's largest lender, State Bank of India, pays between 0.5 and 0.66 per cent for tenures of one to three years for the existing gold deposit scheme. Mehta believes the rate on offer could have been made higher to attract investors.

 There will also be a tax when you convert the physical gold into paper gold, as it is considered a transfer by the I-T department. You will get indexation benefits, so that the tax component comes down substantially. Still, be prepared to shell out some money after you have converted your physical gold into paper gold.

Gold bonds

 Those in the sector feel this is meant more for the sophisticated investor. "Typically, investors who want to diversify their portfolio, after having adequate exposure to debt and equity, can look at this," says a financial planner.

 While this paper gold is expected to be a substitute for physical gold lovers, the rate of interest that will be paid will be 2.75 per cent annually on the initial value of the gold. In other words, if you are depositing gold at Rs 26,840 per 10g of 999-purity, the annual interest earned will be Rs 635. These bonds can also be used as collateral for loans.

 "Sovereign gold bonds are a superior option for investors looking to 'invest' in gold. On top of getting the market price of gold at the time of maturity, investors are further incentivised with a 2.75 per cent annual interest. This unique product, therefore, gives a financial product-like return, tagged with the appreciation of a commodity (gold)," says Vidya Bala of Funds India

Issues: However, since the interest will be paid only on the initial value of gold, if the metal's price rises to, say, Rs 50,000 per 10g in the next five or ten years, the interest amount will not change. The effective rate will come down to 1.35 per cent. As Mehta says: "The interest on the bond will be paid on investment value. Even if gold prices move up, the yield will be calculated on investment value and not on the mark to market one (revaluing at current prices). Therefore, the yield calculated from the prevailing market price might turn out to be lower than 2.75 per cent, in the event gold prices have moved up."

 Another important point is the liquidity. Though the bond's tenure is eight years, premature exit will only be allowed after five years. "Liquidity is a major issue with this scheme. The question is whether there will be enough buyers in the secondary market when someone wants to exit after five years. Otherwise, one will be forced to exit at a loss. Today, people can easily sell their gold holdings to jewellers," says a sectoral player.

Gold coins

 The government has also proposed to introduce India gold coins of 5g, 10g and 20g, with 999-purity. Initially, these will be available at MMTC outlets and later with banks and post offices.

Issues: It will be interesting to see how the government prices these. At present, buying of gold coins from banks or well-established jewellers comes at a premium.

Source: Business-Standard

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