GOLD: Tradition may stop golden opportunity
By Krishna Guha and Gillian O'Connor
A wedding in rural India is a spectacle of glorious colour, lavish celebration and elegant ritual. It is also the foundation of a global industry: the world gold trade.
India is one of the poorest nations, with a per capita income of about a dollar a day. Yet it is the world's biggest buyer of gold, and has the largest hoard of gold, about 13,000 tonnes, almost all of it in private hands.
Demand from India accounts for at least a fifth of world consumption, and with a run of good harvests and economic growth of at least 6 per cent expected this year and next, underlying demand has been growing rapidly. But the gold market may be in for an unpleasant surprise.
Indian policymakers have long regarded the obsession with gold as a throw-back to a medieval past, a threat to the balance of payments and a wasteful diversion of savings into a non-productive asset.
Last year, India imported more than 600 tonnes of gold, at a cost of almost $7bn, a big factor in the worrying rise in non-oil imports. In January, the government resorted to increasing the customs duty on gold by 160 per cent to try to curb the outflow of funds.
But in his budget speech, Yashwant Sinha, finance minister, set out a blueprint for a new strategy. He hopes to mobilise India's gold reserves to help meet demand. Last month the State Bank of India launched its gold deposit scheme. Under the scheme an individual, family, company or trust can deposit as little as 200g of gold for three to seven years in return for a gold certificate, which pays an interest rate of 3 to 4per cent, tax free. At the end of the term the certificate can be exchanged for an equivalent amount of gold, or the market value of the gold, with no capital gains tax.
The certificates are transferable, and can be used as security for a loan. Gold deposited can be withdrawn early, with an interest penalty.
"We have taken pains to ensure that this is investor-friendly," says G.G. Vaidya, State Bank chairman. "No banking product has been made available with such extensive tax concessions, and without any ceiling."
State Bank will lend the gold to local jewellers at an annual interest rate of 9 to 10 per cent, less than the cash borrowing rate. The interest spread will pay for assaying, refining, local tax, and hedging against the risk that the bank will not be able to lend all its gold for periods to match the deposits.
"We have set a target of 100 tonnes in the first year," says Mr Vaidya. "That would mean a saving of about $1.2bn in foreign exchange."
He is confident that private households will take advantage of the opportunity to earn interest on their gold, but the scheme faces formidable obstacles.
Most of the gold in India is in the form of jewellery, which would be melted down on deposit, destroying the value of the work, which is usually about 15 per cent. It would be returned as bullion.
Moreover, most of the gold has been bought with non-declared income, which its owners are reluctant to declare for fear of investigation by tax officials. And even the State Bank's 9,000 branches do not reach into the heart of rural India, where the culture of gold is most deeply rooted.
"There will definitely be some flow, but it may not be enough to have a significant impact on the balance of payments," says Abheek Barua, economist at DSP Merrill Lynch in Bombay.
In London, gold analysts are cautious about the scheme's chances of success, at least in the short term, and think it would be doing well to pull in 50 tonnes in the first year.
Paul Walker, a director of independent consultants Gold Fields Mineral Services, says the government is unlikely to meet its target of 100 tonnes. He says that even if the scheme attracts a high proportion of temple gold - given to temples and believed to total about 1,000 tonnes - that might well be a one-off, with less coming in the second year.
But he says the most obvious deterrent to private owners would be the overnight loss of value suffered when they handed in a highly worked piece of jewellery to be melted down.
He also believes that relatively unsophisticated people who own the most gold trust neither the government nor the financial system, and will be extremely reluctant to lose control of their precious metal.
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