Kerala Chief Minister Oommen Chandy has opposed the Central directive to deposit gold belonging to the state’s temples in banks. This was in the backdrop of the government’s proposal to monetise the country’s large reserves of gold. As per the World Gold Council, temples in India have about 2,000 tonne gold, half of that held by Fort Knox. India, one of the world’s largest consumers of gold, imports 800-1,000 tonne each year. Our huge appetite for gold is one of the reasons the rupee tumbled and worsened our current account deficit in 2013.

Gold has a strong correlation with inflation and interest rates. In times of high inflation or a low real interest rate environment, the purchasing power of an economy decreases. People buy fewer goods and services for each rupee earned. There is a greater need to invest in gold as a hedge against inflation since savings are rendered unattractive.

Gold is perceived as an unproductive asset that drives household savings away from the markets. Of India’s estimated 20,000 tonne gold, most is in the form of jewellery, which is rarely traded or brought in circulation. To monetise it, Finance Minister Arun Jaitley proposed a gold monetisation scheme. It aims to unlock the value of gold reserves and create new financial products with gold as underlying asset. The scheme will replace the current gold deposit and gold loan schemes run by some banks, which provide loans against gold. Depositors will earn interest on their gold accounts and jewellers will also be able to obtain loans on their gold accounts.

The government has also proposed redeemable sovereign gold bonds (SGB), which will carry a fixed interest rate. These will be redeemable in cash on the face value of gold. Similar to gold exchange traded funds (ETFs), an amount equivalent to the value of gold would be paid to the investor at the time of redemption. Instead of investing in physical gold that carries the hassles of safety and purity, investing in ETFs or SGBs is smarter. It carries no making charges, no threat of theft and is easy to sell or buy.

A large number of gold buyers belong to rural areas. In the absence of adequate investment opportunities, the money often gets channelised to gold and real estate. If attractive financial instruments can be created to serve this section, demand for gold will eventually drop. Operating the monetisation scheme through banks and Jan Dhan Yojana will help its benefits trickle to all sections of society and discourage borrowings from moneylenders. Banks will be able to productively use the gold held by households. This will lead to lesser imports and import duties, and eventually bring down the price of gold.

The benefits of gold monetisation will be felt only if the economy is able to keep inflation under check. Positive real interest rates and efficient capital markets will go a long way in ensuring the success of the scheme. Chetan Subramanian, associate professor of Economics at IIM Bangalore, stresses that such schemes are effective provided real returns from these are high. If the investment climate is such that the return on investment is low, the schemes are counterproductive as they simply serve to raise inflation. It is important to keep in mind that the schemes are welcome but not a panacea for the larger structural issues that confront our economy.

Indians have a tendency to save. It is important to nurture this habit and encourage them to invest their money in these new schemes so that both the individual and the economy are in a win-win situation. Gold at home often has no value other than being an heirloom, which is passed on from generation to generation. The same holds true for the gold held in temples. Monetising gold will increase the purchasing power of people, provide them with liquidity and convert gold savings to economic investments.

Economist Hernando De Soto said, “We have had all this land that has all this oil, that’s got all this gold, probably for eternity, and it can only be developed through capital. And the only thing that can attract capital is the ability to go to the markets and demonstrate that it can be monetised.”

(The writer is Director, PeakAlpha Investment Services)