The sharp fall in gold prices in India following Finance Minister Nirmala Sitharaman’s announcement reducing import duty on the yellow metal from 15 per cent to 6 per cent, could affect the loan amount of millions of borrowers.

Why?

Banks and NBFCs will now have to redo their math for their gold loans depending on the price of the metal.

Credit against bullion is essentially a secured loan and the amount that a borrower gets is directly proportionate to the amount of gold jewellery or the metal he or she has deposited with the banks or NBFCs.

So, as long as the prices are going up, the borrower can enhance the loan amount but in case of a price drop, she would be required to deposit either more metal or cash equivalent to make up for the loan-to-value ratio.

While messages sent to Muthoot Finance and Manappuram Finance on the issue went unanswered, the websites point out how the gold loan dynamics work. 

“Gold loans are typically offered at a loan-to-value ratio (LTV) of 75-90%, meaning you can borrow up to a certain percentage of your gold's value. So, if the gold price falls, the value of your pledged gold decreases, potentially triggering a margin call from the lender,”  Muthoot Finance website said.

Importantly, it added that in case of a price drop, the borrower will be required either to deposit additional cash or gold to maintain the LTV, or risk having the loan recalled.

An official with an NBFC dealing in gold loans on condition of anonymity said that the move will primarily impact the existing gold loan borrowers.

“It is important to maintain the LTV and with the prices crashing in the market following the reduction in import duty, the existing borrowers who have got credit on their gold or gold jewellery will face troubles. We also need to understand that most of these borrowers come from smaller towns and have taken loans by securitising gold to get quick money to tackle exigencies,” the official explained. 

Demand for gold loans has been rising in the last few years, especially since the Covid pandemic. Monetising gold has become easy on one hand and on the other, the economic shock post-pandemic has also led to a surge in gold loans.

The demand for gold loans is dominant in smaller towns or rural areas.

“To enhance domestic value addition in gold and precious metal jewellery in the country, I propose to reduce customs duties on gold and silver to 6 per cent and that on platinum to 6.4 per cent,” Sitharaman said in her budget speech. 

Confusion Over Sovereign Gold Bond Redemption

Along with the borrowers, those who invested in sovereign gold bonds (SGB) may also be in for a rude shock.

The tranche that was issued on August 5, 2016 is scheduled for redemption. Investors have been getting an annual interest rate of 2.5 per cent since the issuance. With the gold price spiking the investors were expecting a handsome return.

Though Revenue Secretary Sanjay Malhotra assured that investors will get a return of at least 12 per cent, including interest, notwithstanding the reduction of customs duties on the previous metal, there is apprehension that the returns will be lower than expected.

The redemption value of the SGBs is linked to the prevailing price of gold at the time of redemption value, was pegged on the gold prices of the day. Investors were issued these SGBs at a price of Rs 3,119 per gram. 

Gold Loan Market in India

In the post Covid pandemic phase, the demand for gold loans, especially among those in smaller towns and rural areas has surged.

According to RBI data, the total outstanding loan amount on gold jewellery as of March 2024 was Rs 1,02,658 crore, up from Rs 89,382 crore in March 2023. This is an increase of 14.9 per cent.

Though the growth has been a little slower compared to 19 per cent recorded in the previous year, it is above RBI's tolerance level. In March 2022, the outstanding amount was Rs 74,665 crore.

As long as gold prices are rising, there is no fear but in case the prices drop, the impact could be far reaching, affecting the overall economic health of the country.