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Does the gold scheme change the way you invest in gold?

Except for temples and other large institutional holders, the new gold deposit scheme doesn't change anything for gold as an investment

Last week, draft details of the new and improved version of the government's gold deposit scheme were released. The proposed new rules had some surprises, which were mostly pleasant. The interest rate is likely to be higher, although the actual number is not known yet, the minimum limit has been reduced from half a kilo in the old scheme to just 30 grams now, and most surprisingly, there will be no tax--either capital gains tax or income tax--on the interest earned.

However (there's always a however in tax matters), it appears that the tax exemption is still not a done deal, and the revenue department is still not entirely on board with these exemptions. Be that as it may, the initial excitement in the newspapers has gotten some small investors excited. At first sight of the headlines, it does appear that all you have to do is to store your jewellery in a bank and get two or three per cent interest on it. But obviously, that's not possible because the bank has to earn that money from somewhere and it can only do so by lending your gold to someone else to use, exactly the way banks do with money.

To lend the gold for onward use, it has to be tested, certified, stripped of any precious stones etc, melted and made into standardised coins or bars before it can be deposited with a bank. From an individual jewellery owner's perspective, the jewellery itself has to be destroyed, leaving behind only its monetary value. Given the generally dubious purity of jewellery, as well as the poor resale prospects of precious stones, I don't see small jewellery holders getting too excited about scheme once they get to know the details.

This story is entirely about institutional and temple gold and the government's attempt to use that to lower the gold import bill. In elementary terms, this scheme is an attempt to create a fractional reserve banking system for gold, whereby the same bit of gold can simultaneously appear to be in use by more than one entity.

So, contrary to some investors' initial impression, this scheme has no role to play in turning your household jewellery into an interest-earning investment. The pluses and minuses of treating gold as an investment stay unchanged.