The Union Cabinet's approval to scheme for gold monetisation and gold bonds on Tuesday could reduce imports of the yellow metal.

If the Reserve Bank of India issues the bonds before the festival season, investors can buy and sell the more convenient paper gold and avoid paying premiums for physical gold. Many sellers charge a premium of 1030 per cent on gold coins and bars for vetting the quality. The premium is not available when selling gold back to them.

The additional interest on gold bonds should encourage investors. Also, these bonds will be traded on exchanges and there will enough liquidity.

However, the secondary market will take time to develop. With the government allowing investments up to 500 gm a year, at existing prices, a family of four can invest ₹ 53 lakh a year in paper gold.

India spent $ 280 billion in gold imports in the last 10 years. That is more than the foreign institutional investment in equity and debt in the same period. In a sense, we became exporters of capital rather than importers. The gold bond and monetisation scheme will help us recirculate the gold and save dollars.

The monetisation scheme will unlock value of the gold lying idle with households. Like fixed deposits, there will be a penalty on premature redemption. Short- term deposits can be redeemed in gold or cash but medium- and long- term deposits can be redeemed only in the rupee equivalent of the weight of the deposited gold at the prevailing price. The interest earned will be based on the value of gold deposited.

Despite reducing the minimum deposit to 30 gm, there are fears that the income tax department will seek to know the source of the gold. " Another issue is the tax implication on conversion of physical gold. If gold was bought at ₹ 1,000 per 10 gm and converted into a gold deposit scheme at ₹ 25,000, there will be a capital gains tax with indexation," said an income tax expert.

Experts said the tax should only be imposed when gold was being sold and not when it was being converted, as done in other asset classes like property and debt.