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The Future is Digital Gold

Nirupama Soundararajan & Arindam Goswami Pahle India Foundation

India has traditionally been a gold loving country. Naturally, Indians are more accustomed to thetouch and feel of gold. This has resulted in accumulation of a huge house held reserve of goldover the years. In 2013, rising import bills and widening current account deficit (CAD) drove the government to take short term corrective measures to restrict the import of gold. Although such moves brought some respite in terms of official imports, grey market trade was reported to have gone up.

Late in 2014, the present day government, realising that such short term measures are bound to backfire in the long run conceptualised the idea of gold monetisation. Gold monetisation was focussed on two aspects, ensuring that above ground house held stocks of gold are brought into the formal financial sector, and two, to push investment demand from physical gold to dematerialised gold. In fact, both the Gold Monetisation Scheme (GMS) and the Sovereign Gold Bond (SGB)scheme were introduced to achieve these objectives.

On the trade side, in order to improve access to gold, the government has decided to set up a gold (bullion) spot exchange in the country. Apart from bringing transparency in bullion transactions,the exchange can act as an alternative channel for retail investors to buy and sell gold. Digital gold or dematerialised gold will pave way to better and more seamless monetisation of above ground stock of gold and holding of investment gold.

Digital gold is not new to India. To put it simply, digital gold is dematerialised gold, quantified in terms of grammage, recorded in a digital format and is backed by physical gold. It allows for participants (both institutional and retail) to trade gold in a smaller denominations, even in decimals, in a transparent and convenient manner. The National Spot Exchange Limited (NSEL) ran successful gold spot contracts that were held in their dematerialised form by investors. This was by far their most successful product. This was ofcourse discontinued after NSEL was shut down. Notwithstanding, the concept of dematerialised gold was popular and the demand for the product indicated that maybe modern India was ready to shift from physical to digital gold.

It is however not just about catering to the millennials. Dematerialised gold offers other benefits. Dematerialised gold is always backed by physical gold as its underlying. For all practical purposes dematerialised gold is gold in the financial system. This means that one can take for granted the quality and purity of the underlying. This is an important aspect for financial institutions to participate in any monetisation scheme.

Digital gold is a recent product innovation that has no regulatory frameworkat present. It probably does not require one per se either. Gold vaults and custodians will however require regulations and guidelines for functioning.

Digital gold will have multiple benefits on the gold ecosystem and on gold monetisation. First, in its dematerialised form, gold transactions will become more transparent and efficient since it will only involve a book entry rather than the physical movement of gold. Second, GMS, which is yet to meet with its much anticipated success, will get a facelift. If banks are allowed to accept dematerialised vaulted gold in GMS, the minimum deposit in GMS can be considerably lowered to one gram, if not lower. This would also reduce the costs of transaction significantly since the deposits would be a book entry rather than physical transfer of gold. Third, it will facilitate the conversion of physical gold into digital gold for retail consumers.

Currently, banks are mostly dependent on imported gold for lending and sale to bullion dealers and jewellers.Dematerialised gold will enable the creation of a reverse logistics system which the banks will be able to use to source gold in the smallest denomination from both institutional and domestic retail customers, in the most transparent manner. This will reduce banks’ dependence on import to a large extent.

Furthermore, with the adoption of digital gold, new gold backed financial products can be developed. If physical investment in gold needs to be reduced, consumers must have gold based financial products to invest in. Hence, product innovation is key. Some of these products could be the Gold Savings Account that allows investors to open a metal savings account through which gold may be bought, sold, accumulated and dematerialised. Reverse mortgage pension products may also be thought off. Similarly, insurance policies with assured metal delivery on maturity (or its monetary equivalent) is another product. It is hoped that with digital gold becoming more and more ubiquitous product innovations will happen.

The concept of physical gold being dematerialised and converted to digital gold may sound both laborious and challenging. However, history shows that our country had faced similar challenges and overcame those in the stock market. However, with the introduction of the Depository Act of 1996, SEBI was able to establish a smooth system to enable the transfer of physical share certificates to dematerialised form. Twenty years hence, the percentage of physical shareholding compared to dematerialised form is minuscule amount. Suitable best practises from the stock market and commodity derivatives market and the necessary regulatory impetuscan help in differentiating financial gold from non-financial gold. The only difference should be the form in which it is held. Financial gold must always be held in a dematerialised form. This will be the key to monetising gold and to integrating gold as a savings product into the financial system.

Disclaimer: Views are personal and not the views of the publisher.