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The gold deposit scheme announced by the ndian Finance Minister aims to
draw out a part of country's vast gold holding in private hands and thus
reducing ndia's dependence on importation of gold. With approval from the
ndian Central Bank, ndia's largest commercial bank ("SB") plans to launch a
gold deposit scheme (GDS) on November 15, 1999, whereby they will issue
interest bearing certificates against gold collected from households, temples
and trusts.

This is a controversial development and merits an in-depth analysis. A lot can
be said both in favor of this scheme and against it. The ndian Finance
Minister, backed by the Central Bank, has, obviously, found value in this
scheme. On the other side there are many who believe that by launching this
scheme the government plans to speculate in the gold market from the short
side. f the POG rises sharply or if the ndian rupee devalues sharply against
the US$ then the cost of borrowing gold will have terrible consequences for
the ndian financial system.
The salient features of the SB's gold deposit scheme are:
1. nterest bearing certificates will be issued against gold deposits.
nterest rate is likely to be about 3.5 % per annum.
2. Certificates will be redeemable in gold or rupee equivalent on
maturity, at the discretion of the depositor.
3. Minimum deposit 200 grams of gold.
4. Certificates will be transferable by endorsement and delivery.
5. No capital gains tax, wealth tax or income tax on the deposits.
6. Maturity 3 to 7 years
7. Premature redemption in gold will be permitted after the minimum
lock-in of 1 year.
8. SB will give rupee loans against the certificates.




The State Bank of ndia (SB) will sell the gold collected under the scheme in
the local market and thereby reduce ndia's dependence on imported gold.
The Central Bank will provide a forward cover to SB at a cost. This cost plus
the interest on the certificate will more or less equal the SB's rupee borrowing
rate. n other words this is an attempt by the government to convert physical
gold into paper gold backed by the ndian Central Bank.
Making or accepting a gold deposit is not as simple as it sounds. Nearly all the
gold held by ndian households is in the form of jewelry. Jewelry deposited
under the GDS would be melted down and refined to pure gold bars. Since
jewelry is a value added product, its purchase price is 25% to 100% more
than the value of gold content. Under the said scheme this value addition
would be lost. At the time of accepting the deposit, the Bank will have to test
the purity and issue the certificate based upon the exact gold content.
Thereafter, the Bank will have to melt this jewelry and refine it to pure gold
bars. n addition to losing the value addition, the depositor of jewelry will have
to bear the cost of testing the purity and the cost of refining. This effectively
means that only scrap jewelry would be available for deposit. This leads us to
an important question, that is, what is the availability of scrap jewelry? Poor
people do not scrap jewelry as they can get it polished very economically.
After polishing, the jewelry recovers its lost shine and is as good as new. Very
rich people do exchange their old-fashioned jewelry with the latest designs.
am unsure whether they will be willing to exchange their old jewelry for paper.
n any case not many households will have 200 grams of scrap jewelry.
Temples and religious trusts own a lot of gold in the form of jewelry. The
majority Hindu population in ndia believes in idol worship. The jewelry owned
by the temples and religious trusts have been gifted by the believers to
decorate the idols of God. Government has a significant influence on the
management of these temples and trusts. They may use this influence and
persuade the management of these temples and trusts to deposit this gold
with the Banks. At the same time there are many diehard believers who would
lay down their lives if the "ornaments meant for God" are deposited with the
banks in exchange for paper. History is a witness that a lot of lives have been
lost in ndia because somebody made the mistake of shifting an idol from one
place to another. f some religious leader shouts that the necklace of "Lord
Rama" has been deposited with SB and they have melted it down, then the
Government could fall in New Delhi. n ndia, or for that matter anywhere else
in the world, one cannot play with the religious sentiments of the people.
believe that unless the deposits are made secretly, there is no chance of this
gold finding its way to the Bank.



The government has announced that there will be no capital gains tax or
income tax or wealth tax on these deposits. What they have not announced is
whether the depositor will be asked to account for the gold. Most of the gold
held privately in ndia is unaccounted. This means that it has been purchased
with the money on which no income tax was paid. To make the scheme
successful the government may amend the terms to "no questions asked". f
that happens then a lot of gold will be deposited under this scheme. What will
then happen is that people will buy gold with their unaccounted money and
deposit it with the Bank. The stated purpose of the scheme would then be
defeated as the quantity of gold deposited will more or less equal the
increased demand.
ndian rupee is not convertible on capital account. This means that people can
not convert their rupee deposits with the Banks into foreign currency deposits.
The GDS offers them a chance to convert their rupee deposits into gold
deposits. A lot of people may opt to withdraw their Bank deposits and buy gold
bars. They may then deposit these gold bars with SB in exchange of interest
bearing certificates. f people convert their rupee deposits to gold deposits
then the scheme would be a miserable failure from the government's point of
view for the following reasons:
1. The increase in gold demand would more or less match the
quantity of gold deposited under the GDS.
2. The government would lose a lot of money if rupee devalues
sharply against US$ or POG rises sharply during the tenure of
deposit.
3. nterest earned on gold certificates is not taxable while interest
income on rupee deposits is taxable.
The ndian Central bank has gold reserves of about 350 tons. This gold is not
earning anything for the Central Bank. Yet they have chosen to borrow gold
from the people and pay an interest. f SB manages to raise significant
quantity of gold under the GDS and the Central Bank provides them with a
forward cover then it means that Central bank has sold their reserves for a
possible (probable) future delivery. What is the logic for not selling the gold
reserves and choosing to launch the GDS? To get a possible answer to this
question one would have to go back a bit in time. n 1991, when ndia had to
pledge its gold for a short-term loan, there was a big hue and cry at home. t
was as if the country had been sold off. t also became a political issue during
the 1991 elections. n other words, ndians are very possessive about the
country's gold.

n September this year when gold was trading at record lows, S.S.Tarapore,
former deputy Governor of the ndian Central bank gave an interview to Dow
Jones Newswires. He said "Reserve Bank (ndian Central bank) mustn't jump
on the bandwagon and sell because the time to sell is when you anticipate a
fall in gold price, not after the gold price has fallen steeply and the next cycle
of gold rise is going to come." He suggested that the ndian Central Bank
should increase its gold reserves. How prophetic were his words! The
relevance here is that there is a lot of opposition to selling of gold by the
ndian Central bank. By coming out with a gold deposit scheme the people in-
charge are trying to camouflage the gold sale by the Central Bank and making
it look like a typical financial market product. The common man in ndia does
not understand that this scheme is nothing but a forward sale of the reserves,
thus, making it very difficult for people to criticize this scheme.
There was a time when gold was money. Slowly it was replaced with paper
currency fully backed by and redeemable in gold. Till 1971, any US dollars
owned by foreigners were redeemable in gold. People who owned dollars as
credits of balance of trade were shocked by the 1971 declaration (by the US)
terminating the redemption of dollars for gold. Those who trusted were left
with paper worth only as much as the market forces would allow it to buy.
Today we have a financial system based only on trust. Although most ndians
do not know about the 1971 declaration still, believe, they are wise enough
and will not part with their gold for interest bearing certificates. Aren't these
certificates as good or as bad as the pre-1971 dollars? f a few years later, for
any reason, the government of ndia finds that it can no longer honor its
commitment to redeem these certificates with gold then they may offer rupees
at a convenient rate on a "take it or get nothing basis". One more paragraph
would then be written in the world's history of financial defaults.










Go|d Depos|t scheme
SBI Gold Deposit Scheme
SBI has launched a Gold Deposit scheme to make use oI privately held stock oI gold and reduce
country's dependence on imported gold. This scheme was earlier launched in 1999 but wasn't
successIul then. But we think this would be a good time Ior a bank to make use oI high gold
prices and thus would make a lot oI sense now.

The scheme invites investors to deposit their surplus gold, in any Iorm, with the bank and earn
interest on the same. The minimum amount oI gold deposit is pegged at 500 grams (1/2 kg),
which is probably beyond the reach oI general public at large but Ior high networth individuals,
temples and trusts, this would be a great investment opportunity. The gold which was lying idle
in locker oI a bank can now earn them interest.

The gold so deposited with the bank shall be checked Ior purity and melted at the Government oI
India mint. A certiIicate oI purity will then be issued by the Government, which can be used by
the investor to claim back the gold aIter the maturity period. The bank has also clariIied that the
expenses incurred on assaying oI gold shall be borne by the bank and will not be passed on to the
customer. During the investment tenure, the deposited gold will earn an interest, which is
currently tagged as 1 (3 years), 1.25 (4 years) and 1.5 (5 years). The investment shall
be locked-in Ior one year.

Premature withdrawal, aIter the lock-in period but beIore the maturity, shall attract a penal
interest oI 0.5 iI withdrawn within 3 years and 0.25 thereaIter.However, unlike the regular
deposits, interest here is calculated in grams and not in rupees. Thus, an investment oI 500 grams
oI gold Ior three years shall earn 5 grams oI gold as interest per annum, compounded annually.
At the end oI the maturity term, the interest so earned shall be converted into rupee equivalent oI
gold then and paid to the investor. For the principal investment, investor will have an option to
claim back pure gold (0.999 purity) or cash equivalent oI gold as on that day. The scheme is also
attractive Irom tax perspective as the interest earned as well as tax on any capital gains arising
Irom rise in price oI gold aIter maturity is exempt Irom tax. Gold so deposited has also been
exempted Irom wealth tax.

For small individual investors, this is out oI reach. However, investment in Gold (though not in
form of jewellery) will make a lot of sense in 2009 and would Ietch good return in a 6 months
to 1 year time Irame. Reason Ior that is simple - countries will try to devalue their currencies to
be more competetive globally so no investor or bank would have Iaith in the Iorex oI any country
in the short term to medium term. Gold is the best asset class to hedge against that scenario. So,
Gold prices are bound to go up in 2009. However, small investors should either buy gold coins
which they can easily sell or they can invest in Gold ETFs (Exchange traded Iunds). The gold
prices are currently at Rs 15000/-. Sell them when the prices reach 18000/-. That would be 20
return on investment within 6 months. Not a bad deal at all!

SBI relaunches gold deposit scheme as import costs rise
Gold deposit scheme is back. The rising cost oI gold imports has once again prompted
the largest public sector bank oI the country SBI to relaunch its gold deposit scheme to help
bring privately-held stock oI gold in circulation and reduce country's dependence on
imported gold.
This scheme, which was Iirst launched in November '99 at the initiation oI the then Union
Iinance minister Yashwant Sinha in the Budget 1999-2000, did not gel well with the public at
large and was thus withdrawn within a Iew years oI its launch.
The scheme, as the name suggest, invites investors to deposit their surplus gold, in any Iorm,
with the bank and earn interest on the same.
India being a country where gold commands more oI an emotional attachment than a mere
source oI investment amongst the masses, the scheme is targeted only to those aIIluent and high
net worth investors, temples and trusts Ior whom gold is just another asset class.
The minimum amount oI gold deposit is thus pegged at 500 grams (1/2 kg), which is probably
beyond the reach oI general public at large.
Famous temples across the country are known to receive huge donations in gold and they are
likely to be most preIerred customers Ior the bank under this scheme.
During its previous phase, the scheme had garnered 400 kgs oI gold alone Irom Guruvayur
Devaswom in Kerala. II the scheme does a turnaround this time, it may Iind its potential
customers in the very Iamous Siddhivinayak Temple, Mahalaxmi Temple, Lalbaug Ka Raja and
Shirdi's Sai Baba Temple to name a Iew.
The scheme has just been re-launched and is available only at select SBI branches. Currently,
only 50 branches across the country have been nominated to accept these deposits oI which Iour
are in Maharashtra.
Only two branches in Mumbai have been nominated Ior the purpose, namely, Mumbai Main
Branch and Shivaji Park Branch. The bank is also setting up a separate branch at the gold hub oI
Mumbai Zaveri Bazaar to manage these deposits.
The gold so deposited with the bank shall be checked Ior purity and melted at the Government oI
India mint. A certiIicate oI purity will then be issued by the Government, which can be used by
the investor to claim back the gold aIter the maturity period.