How about a gold small savings scheme?

Small savers need a safer alternative to the unregulated gold savings schemes run by jewellers

Has demonetisation prompted the Indian saver to abandon traditional options such as gold and make a beeline for financial assets? Financial firms and stock market investors certainly seem to think so. But the wave of panic that swept Chennai this week after a reputed jewellery chain defaulted on its gold savings scheme, reminds us that a large cross-section of Bharat remains immune to the charms of mutual funds.

It is not newfangled instruments such as Gold Exchange Traded Funds (ETFs) or Sovereign Gold Bonds (SGBs) that attract these savers. Instead, at least in the southern States, it is the unregulated Thanga Kuviyal, Golden Deposit and Golden Advance schemes offered by neighbourhood jewellers that are magnets for this money.

Vulnerable to a run

The main attraction of jeweller-backed gold savings schemes for the aam aurat (or aadmi) is their simple design. Every month, the customer deposits a fixed instalment as small as ₹500 with the jeweller. At the end of 12 months, she is free to swap these savings for an equivalent value of gold jewellery, or roll it over for another year. Customers do not seem to mind that jewellers often do not offer any interest on these ‘deposits’. While a few throw in a free 12th instalment as a sweetener, others use low making charges or freebies as the lure. These schemes, widely misunderstood as ‘gold deposits’ or ‘gold chits’ (they are neither, as the deposit takers are not registered under the Companies Act or the Chit Funds Act) are in fact such a household phenomenon in Tamil Nadu that they serve as a significant source of working capital funding to the jewellery industry.

The unregulated nature of these schemes allows them to raise prodigious amounts without sticking to any end-use criteria. This makes them vulnerable to the fluctuating fortunes of the jeweller. Even jewellers who have no intention of defaulting may be forced to renege on payments if subjected to a run by panicky customers, as they maintain no capital buffers or redemption reserves against these dues. Indeed this is what may have transpired at Chennai’s Nathella Sampath Jewelry this week, wherethe jeweller has officially admitted to a financial crunch and sought more time to honour commitments.

Nor are such defaults by jewellers uncommon. Over a decade ago, Bharathi Gems and Jewels was hauled to court by its 9,100 depositors for defaulting on repayments. As recently as September, financial papers reported a SEBI investigation into the Kerala-based Chemmanur International Jewellers for allegedly collecting over ₹900 crore in ‘advances’ from the public as part of a gold scheme.

Regulatory no-man’s land

Surprisingly , these gold savings schemes despite being a household phenomenon and raking in hundreds of crores every year, essentially operate in a regulatory no-man’s land. Despite their ostensible drive to rein in illegal money-pooling schemes, the ministry of corporate affairs, SEBI and RBI have all been citing jurisdictional issues to keep gold savings schemes out of their regulatory ambit. Section 45S of the RBI Act expressly bars unincorporated entities from accepting public deposits, and companies accepting such deposits are required to register themselves as NBFCs with the RBI. However, the RBI has been wary of extending its regulatory reach to jewellers’ schemes.

SEBI won exceptional powers to regulate Collective Investment Schemes that pool Rs. ₹100 crore or more, after the Sahara and Saradha scams broke a few years ago. It has since issued a rash of orders against Ponzi schemes promising astronomical returns from investing in orchards, agricultural land, goat-rearing and the like. But none of the orders has featured gold savings schemes. The explanation could be that most of these schemes slip under the radar by mopping up less than ₹100 crore or aren’t reported to SEBI. The rebooted Companies Act of 2013 tightened the screws on companies accepting public deposits by asking them to set aside redemption reserves, cap their deposits at 25 per cent of networth and restricting their interest payouts. Large corporate jewellers such as Titan Industries wound down their gold savings schemes with alacrity after this change. But perversely, the more risky unincorporated jewellers have been let off scot-free and collect gold ‘deposits’ under the guise of trade advances. The net effect of all this is that a rash of gold savings schemes continue to flourish.

A gold accumulation plan

The reaction of Indian policymakers is to either to impose an outright ban or to blame it all on investor greed. But greed clearly isn’t a factor here, because many savers frankly don’t even seek a return from their gold schemes. These schemes have proliferated mainly because they satisfy a deeply felt need of the Indian saver — that of accumulating unaffordable gold through byte-sized investments.

So what should policymakers do now? Well, that gold savings schemes from unincorporated jewellers need to be regulated is a no-brainer. But it is equally essential that the small saver is offered a simple, safe alternative that meets her felt need for gold accumulation. Today, gold ETFs from mutual fund houses and tranches of Sovereign Gold Bonds (SGBs) sold by the RBI via banks offer two regulated avenues for investors to own gold in paper form and replicate its returns. But gold ETFs require the investor to own a demat account and be familiar with the workings of the stock market. SGBs permit only lumpsum investments at a fixed price, aren’t easy to understand and carry a long lock-in of 5-8 years. Both instruments are presently used mainly by informed investors.

Reworking the SGB scheme into an on-tap format that allows the saver to invest in instalments is one option. But a better one would be for the Centre to push for a Gold Accumulation Plan from banks or India Post, which simply replicates the features of the jewellers’ schemes. In fact, it makes eminent sense to add a Pradhan Mantri Swarna Sanchay Yojana to the menu of financial products already available to PMJDY account-holders. Banks or post offices can be incentivised through a commission on each instalment.

There are two risks to rolling out GAPs on this scale. Issuers offering these schemes will need to back every purchase with physical gold or hedge against the gold price risk. But such risks are already inherent to SGBs and can be handled in a similar fashion. If the scheme becomes a runaway hit, it may bloat India’s gold import bill and send the CAD into remission. But imposing a cap on individual gold purchases can ensure that only small savers, and not speculators, throng to them.