In a previous article, I had suggested that the RBI, on behalf of the Government, should issue RETAIL GOLD BONDS to decrease the import of gold and to rein in the increasing Current Account Deficit and the problems emanating therefrom. First, let me quickly re-present the essential features of this BOND. - the Bond should issued in denominations of GOLD grams - the Bonds would be perpetual but the holder can redeem the value of the Bonds at any time by presenting it to RBI - the redemption would be in Rupees and equal the value of gold prevailing at that time in India - the Bonds can be purchased either in cash or by submitting an equivalent amount of gold - the Bonds will be bearer in nature with ownership transmitting by mere physical transfer I have made the case that issuing such a Bond is a much better alternative to increasing the import duty on gold as that would only drive the trade in gold underground to the smugglers and the black economy. Duty increase triggers gold smuggling rush There is already an artificial scarcity being seen which is reflected in the domestic price of gold being at a premium to the landed cost. Due to the premium and the Rupee decline, domestic gold prices have increased even while Dollar prices have declined and this has reinforced the retail perception of gold being the only safe haven. Let me now try and elaborate on the benefits of issuing such a Bond: A) Will decrease the Current Account Deficit: A previous report by the RBI on Gold imports states, "The Working Group is of the view that external stability appears to be an issue with large gold imports. Gold contributed nearly 30 per cent of trade deficit during 2009-10 to 2011-12. Due to falling gold re-exports, India’s trade deficit as well as CAD as ratio to GDP worsened by 0.3 percentage points in 2011-12. Projections show that net gold imports as ratio to GDP is likely to be in range of 1.8 per cent to 2.4 per cent in the next few years." The actual situation is much worse than feared. In 2012-2013, gold accounted for USD 54 billion of imports in a Current Account Deficit of USD 88 billion. In the first half of 2013 calendar year, India had already imported a record 566 tonnes of gold, well on its way to exceed a 1000 tonnes in the year! That is nearly 40% of world gold production! If the RETAIL GOLD BONDS succeed in cutting the imports of gold by half, then we are cutting the CAD by over a fourth and equal to a reduction of USD 27 billion (compare that to trying to issue sovereign bond to the extent of 4-5 billion). Rupee depreciation will reduce significantly and we may even see the Rupee appreciating if we structurally reduce our CAD by over a fourth, year on year. B) Will decrease Inflation: One of the major causes of inflation in India has been the increasing Rupee cost of petroleum products and other imported goods because of the depreciating Rupee. The structural benefit in CAD will help in halting the depreciation of the Rupee. This in turn will reduce the domestic inflationary pressures, which has currently become a significant issue. In turn, RBI will be able to ease its monetary tightening, which has been impacting economic growth. C) Opens up a new avenue to finance the Fiscal Deficit: The Government has been trying to figure out an inflation hedge financial instrument to offer to retail investors and wean them away from gold. This fits the bill perfectly. The additional benefit is that it gives the Government a new avenue of financing the Fiscal Deficit, away from the traditional institutional market. USD 25 billion dollars is equal to 1,50,000 Crores, nearly half the net financing requirement. D) Domestic interest rates will decline significantly: Lower inflation and a reduced dependence of the Government to borrow from the institutional market will significantly reduce the crowding out of the market. The RBI will be able to reduce the incremental SLR Ratio of the Banks. More money in the hands of the banks for lending will result in an easing of the domestic interest rates and give a further boost to growth. E) Starts a Virtuous Cycle for the Indian Economy: The wide spectrum of benefits of issuing such Bonds has the ability to put us in a virtuous cycle of a reduced CAD, strengthening Rupee, lower inflation, lower domestic interest rates & higher investment liquidity leading to higher growth, leading to more foreign investment and back to a strengthening Rupee.... F) Could significantly bolster India's foreign exchange reserves: The ease of storage will induce many holders of gold coins, biscuits, bars & ingots to exchange their physical gold for these Bonds. As gold is part of foreign exchange reserves, this will increase India's foreign exchange reserves without a corresponding increase in our foreign exchange liabilities. Indians are estimated to hold more than USD 1 trillion of gold with them. If only 10% of this is exchanged, this will boost India's foreign exchange reserves by USD 100 billion, leading to a significant strengthening of India's financial strength, ratings and investment flows. This will again have a positive impact on the value of the Rupee. Endpiece: A lot of people have asked me whether this could result into a significant open ended liability for the Government by way of increasing gold prices. India is expected to import nearly a 1000 tonnes of gold this year, which is 40% of world gold production! Anyway, we have been importing about 25% traditionally. If India reduces its gold imports by half, world gold prices will crash and the Government will actually benefit by issuing these Bonds, not to say the positive effect it will have of weaning people away from an unproductive investment like gold! A strengthening value of the Rupee will also benefit the issuer. Lastly, if there is continuing trust in these instruments, there will always be a net positive inflow as long as people value gold and if gold is expected to track inflation over the long term - then the government's liability will also be inflation linked, that is, linked to the purchasing power of the Rupee. People have also expressed the concern whether this means a VDIS and the confusion arises from the 'bearer' nature of the instrument. Let me clarify that this is not meant to be an amnesty scheme of any sort! The money accepted by RBI has to be from accounted sources and the capital gains will also be taxable at the time of redemption. The 'bearer' nature of the bond is to impart the same easy liquidity that one enjoys with physical gold as liquidity is one of the key reasons for holding gold as an asset.