In 1991, the Indian government pledged the nation’s gold reserves against foreign loans that were provided to the nation from international sources. So they have already trodden the path of using gold to support their international presence and in international dealings.
The Indian Rupee exchange rate continues to decline, and far faster than other currencies. Over the last couple of years the Indian Rupee has fallen from Rs.42 to the dollar to the current rate of over Rs.63 to the dollar. While this reflects, in part, the withdrawal of ‘hot money’ (carry trade investments taking advantage of interest rate differentials between the dollar and the rupee) from the country, it also reflects the waning confidence in the Indian economy –although it continues to grow at over 5%—and its currency. The Balance of Payments continues to worsen.
This has precipitated the imposition of Capital Controls on just Indians, for the moment, but if the situation continues to decay, then we expect these to widen to capture foreign investments within the country and to prevent their exit. India is in crisis!
The Indian gov’t is fully aware that their options are limited, but they have to do something and soon. The use of privately held gold is an option and one, we believe, for which they are preparing.
Please note that there are around 20,000 tonnes of gold in private hands in India, worth currently, US$ 900,200,000,000 at $1,400. Some believe the tonnage to be closer to 25,000 tonnes. If so, this is worth $1,125,250,000,000 at $1,400.
If the Indian government took this gold out of Indian hands into government coffers, confidence may well return to the Rupee, provided the gold were used to support the Rupee, as collateral. Is this likely? It depends on just how bad the crisis becomes. But those who believe talk of confiscation is scaremongering, would do well to look at what’s happening there right now.
The “Save Gold Campaign”
There is a campaign in India, cynically called, “The Save Gold Campaign”, or “Swarna Bachao Abhiyan,” which targets the enormous amount of gold there. This gold is held by ordinary individuals, high net worth individuals, charitable trusts and even temple trusts and banks.
An announcement in this regard was made at the India International Gold Convention currently on in Jaipur in India. An important gold organization called ‘The All India Gems and Jewelry Trade Federation” –which is behind the call to stop selling gold through their branches in response to government requests—held a meeting recently on the subject, in the light of the widening current account deficit.
Vinod Hayagriv, the ex-chairman of the All India Gems and Jewelry Trade Federation said India's Reserve Bank of India, is to frame and regulate the national gold deposit scheme, where eligible jewelers can mobilize gold through eligible banks. The stated objective is to bring this huge amount of gold to the ‘market’. In a joint industry/government move the Federation intends to interact with the finance ministry to discuss new guidelines.
Gold owners will be ‘encouraged to bring their gold to authorized jewelers. The jeweler would then check the authenticity of bullion or coins and issue a certificate and seal the gold, handing it back to the consumer. In the case of jewelry, it would be melted down in the presence of the consumer before the certificate is issued. The consumer would then have to take the sealed gold and authenticity certificate to the bank, which would issue a deposit certificate for a valid period, ranging from one and a half to three years. Thereafter, the depositor would get the gold back with interest, as promised by the bank.
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There is also talk of lending the gold to a non-banking financial company (NBFC) set up for the purpose. The NBFC would allow investors to withdraw the gold before the maturity period, and would lend the gold to jewelers. What is not made clear is why the jewelers would want to borrow gold, if there business is selling gold. How would they access the gold with which to repay such depositors?
Already Tried Without Success
A similar scheme was tried in 1999 with the same objective of bringing privately held stock of gold into circulation and reducing the country’s reliance on gold imports.
Then, the Indian gov’t instituted a Gold Deposit Scheme through the State Bank of India but this met with a weak response, so the scheme was withdrawn and re-launched with modifications in 2009. Again, it failed to meet the objectives, with the reason given that the leading public sector banks in India, which launched the scheme, did not promote it aggressively, as it was done as a government-induced exercise. It excluded the jewelry fraternity. This led to the lack of facilities to melt jewelry, test its purity and convert it into bars which proved a major hurdle. Banks incurred heavy expenditure to melt and convert the jewelry into pure gold bars.
The concept also failed in rural areas, the ‘unbanked’ part of the population, who were reluctant to part with their gold jewelry. They were distrustful of the institutional measurement of their gold and the cost of re-making jewelry once it was to be returned. The religious and emotional attachment to gold and the distrust of government, its bureaucracy and its supportive institutions was completely underestimated. So twice already the scheme has failed.
The government then made certain amendments to the scheme. Mutual Funds and Gold Exchange Traded Funds registered with the Securities Exchange Board of India were asked to deposit part of their gold and make the scheme more attractive for individuals. Then, although the interest income from gold deposit scheme would be taxable like any other income, the gold deposited under the scheme would be exempt from Wealth tax. But again, it excluded the jewelry fraternity.
So Why Is It being Tried Again?
Now with the support of the [jewelry] Federation and its extensive reach all over India and understanding of the gold market, retailers and jewelers will be asked to be a major contributor to the success of the scheme.
The Federation has suggested that there should be no questions asked on the source of gold and that wealth tax should be applicable on the realization of gold. The Federation has also asked that the quantum of gold mobilized under the scheme should be reported on a monthly or a quarterly basis. This, the Federation feels, would work.
The government would have to overcome such distrust, a near impossible task given their poor record to date. The response of the gold owners in India whether they be institutions or not, should be assessed on their past responses. The previous two efforts failed. Like those before this current attempt, the scheme would require a public disclosure of gold ownership by current owners.
The second is that government and its bureaucracies would have access to such knowledge.
But will the gold-owning public trust the Jewelry Federation, knowing the government and banks are behind them?
So we ask again, “Why is it being tried again?” It becomes apparent that the Federation is working with government on this, and the government is becoming desperate to overcome what could be an intractable problem of international credibility. They have to do something.
Jewelers Cooperating to Stay in Business
Likewise, the Federation has to do something so they can stay in business. If the government blatantly confiscates privately-owned gold, these jewelers would lose all, or the bulk, of their business. By cooperating and working with government they stay in business.
But we expect that they will, once again, meet with a poor response. If so, government may well act unilaterally and force the acquisition of gold through confiscation.
Thereafter, it would be a very small step for government to step in and use the gold, so taken, for national purposes and to harness it, to bolster the international credibility of the Rupee.
But the success of such an effective confiscation would need the support of the jewelers and government by providing reasonable payment to gold owners.
The concept that they would receive the market-related Rupee gold price should they wish to withdraw from the scheme is a probability, despite a promise that the gold would be returned at the end of the agreed period. But owners have to ask, will they get their gold price back or will the government or jewelers pay back a market-related Rupee price?
The possibility/probability that this repayment would be in (failing) Rupees would be a necessary evil, simply because the gold would have either been sold or in use by the government. Alternatively would gold owners be forced to accept an “extension” of the period of their gold loan?
As to giving a firm date when the gold would be returned to its rightful owner, owners would have to realize that in the nation’s interests, government most likely would require access to the gold for much longer than agreed. After all, in the U.S. the return of confiscated gold took 41 years.
It may be that the Indian government does manage to handle the crisis without resorting to gold confiscation, but they would be wise to be in a position to do so if they can’t overcome the foreign exchange hurdles. Hence plans “to Save Gold”!
What alternative does government have? It has already begun to impose Capital Controls and gold import controls, so as the situation worsens these controls and the likelihood of gold confiscation increases.
Foretaste of the Future?
We are watching a classic case of the breakdown of a currency and the steps needed to hold onto international credibility of a currency.
Will it happen to other currencies? We have written extensively on the coming arrival of the Chinese Yuan on the international scene. Expect a large widening of the convertibility of the Yuan towards the end of this year.
The Chinese are fully aware of the impact on the global monetary system of this change. They are fully aware that this will break up USD hegemony and bring on a multi-currency system for all. That’s why they are buying gold and encouraging their citizens to do so too. We believe that they too see the necessity for a pivotal role for gold in the new regime and have planned for it.
The fact that there will not be a cohesive system thereafter, calls for gold to have such a role.
We are also sure that the world will not be able to ignore such a role for gold thereafter. Most nations including in the developed world will move to accommodate gold in the future global monetary system for the sake of the international credibility of their own currencies. This will include the present reserve currencies of the world. Central banks across the world will be making contingency plans for such an eventuality for sure.
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