Will Gold in India Lose its Sheen?

            India’s love affair with gold can be dated right back to the epics of Mahabaratha and Ramayana when gold was idolized by the gods and kings, and was the epitome of wealth and stature.  This idea seems to have carried down all through history.  In India, gold has almost become a necessity, let alone a status symbol.  People invest in gold to get their daughters married off, regardless of their financial background.  Gold often gets passed down through generations of women who wear this precious metal almost right from the time they are born.  Gold is also associated with the Hindu goddess ‘Lakshmi’ who represents wealth and prosperity.  In addition to all this, the advent of ‘Akshaya Tritiya’ seems to have coerced people into buying large amounts of gold on this supposedly auspicious day.    

            Apart from the rich culture gold seems to have associated with it, India’s obsession with the yellow metal has several economic reasons as well.  Indians seem to look at gold as a form of savings, rather than investment though national accounts fail to acknowledge this fact.  As a result, gold is getting hoarded and left sitting in lockers instead of being used for productive purposes in the economy.  People aren’t interested in investing in stocks or mutual funds; they would much rather invest in a metal that would not deteriorate and can be easily liquidated in times of dire need.  From an investor’s point of view, gold can never be an idle or unproductive asset provided its value continues to appreciate.  Rich or poor, investing in gold seems to be the most risk-free asset that can help one cope during periods of heavy inflation.  In fact, 60% of India’s gold demand comes from rural areas.  Farmers invest in gold after their harvest in order to meet expenses during the next farming season.  As 60 Minutes correspondent Byron Pitts puts it – ‘In India, gold is financial security that is also a fashion statement.’

            However, this obsession with gold seems to be taking its toll on the Indian economy.  India is one of the countries that produces the least amount of gold, yet has the highest demand for it.  Thus India relies heavily on gold imports – 1,079 tonnes of it during 2011-12.  Gold imports increased from around $40.5 billion in 2010-11 to around $56.2 billion in 2011-12, with most of this coming from Switzerland, the UAE, South Africa and Australia.  As a result, India’s current account deficit stood at 4.2% of GDP, with 60 percent comprising of ‘net’ gold imports.  According to the Bureau of Economic Analysis, current account basically measures trade, as well as international income, direct transfers of capital and investment income made on assets.  A current account deficit signals that a country is importing more goods, services and capital than it is exporting.  And thanks to heavy gold imports, India’s current account deficit is well over the sustainable level which usually falls under 3%.  If this deficit continues to rise, it will make India vulnerable to the external sector and in the long-run, foreign investors may begin to question whether economic growth can provide adequate returns on investment.

            Thus Finance Minister P. Chidambaram has stepped in with a plan to try and narrow the current account deficit.  He feels that the only way reduce the deficit is to bring down the demand for gold by making gold imports more expensive.  He has proposed that customs duties be raised from 2% to 4% on gold coins whose purity exceed 99.5% and from 5% to 10% for non-standard gold.  These hikes are in addition to the ones already implemented in the 2012 budget.  But whether making imports more expensive will actually bring down the demand for gold is certainly questionable.  Gold seems to have fairly inelastic demand in India.  In fact between 2002 and 2011 as gold prices soared, consumption soared along with it.  Another worry is the creation of a black market for gold if customs duties on imports are pegged too high.  People will begin smuggling gold through the borders of Pakistan and Nepal and contribute further to the already infamous Indian parallel market. 

            Chidambaram isn’t the first Finance Minister to express serious concern over India’s excessively high demand for gold; generations of Finance Ministers have tried to implement various schemes in order to bring down the demand.  Some of these suggestions have included financial institutions selling products as proxy for gold, encouraging households to deposit family jewels in fixed deposits schemes that will earn them interest and a pay-back in the form of gold bars years later and a pension scheme which guarantees a fixed amount to a person for the rest of his/her life against gold surrendered to the bank.  Yet each of these suggestions seems fundamentally flawed. First, if banks start selling gold-link financial products then banks will begin to hold gold instead of individuals.  This scenario will not help increase the productivity of gold.  Second, there are very few fund managers that would be willing to offer fixed pension schemes.  And lastly, it is very difficult to get Indians to surrender gold, whatever the reward may be.

            The proposal to bring down India’s demand for gold has naturally sparked debate all across the country.  The government strongly believes that gold is an unproductive asset.  Considering international prices of gold are currently so high, the government feels that money from foreign exchange reserves could have instead been spent on importing assets that would have been of more value to the economy.  Mangalore-based economist Jayadev Moleyar says, “Most gold is in the form of ornaments with the private people in households or are piled in bank lockers for most of the time. Gold doesn't have economic value; it only has emotional value. And considering the heavy pressure its puts on imports, it is an investment better avoided.”  Other experts also feel that gold needs to be circulated productively in the economy and not hoarded, particularly in a country where poverty levels are high and infrastructure is low.

            Another set of experts and the general public however, hit back at the government’s views.  Some experts say that though gold was used primarily for jewelry purposes earlier, the trend is now slowly shifting towards investment.  People are investing in gold keeping in mind long-term benefits.  Gold is almost the only accessible investment option for the rural poor.   The public has further defended their demand for gold saying that the Reserve Bank of India holds gold as reserve for more or less the same reason – financial security.  In fact states such as Utah in the United States have passed laws to make gold legal tender.  People have started blaming poor governance for the widening trade deficit, and not the demand for gold.  Also, in a country where gold holds such a high level of significance during a wedding, it is near impossible to do away with it.     

            On a personal note, the demand for gold in India is unlikely to go down anytime soon, considering its almost sacrosanct nature.  The mindset of Indians that has been cultivated over so many centuries is difficult to change within a matter of just a few months.  The government and the people however, should try and find middle ground and reach an understanding.  The government needs to understand that for individuals, gold is the most reliable and risk-free asset, as has been proven time and again through numerous financial crises.  For many of the rural poor, holding gold is almost a means of survival.  Though national accounts look at gold only as either consumption or investment, the government must understand the value gold savings hold for an individual. 

At the same time, individuals must realize the detrimental effects excessive hoarding may have on the economy.  As they say, ‘too much of a good thing is bad.’  While gold is necessary for financial stability and weddings, large amounts of it left idle in lockers will negatively impact macroeconomic factors.  Considering around 50% of our population is below the age of 25, there is a good chance that a large section of this population will get married in the next couple of decades.  This part of the youth should take it upon themselves to cut down on lavish weddings and only spend wherever necessary.  While increasing the price of imports may have negligible instant effects on the demand for gold, other measures combined with this may be able to slowly bring down demand over a period of time.  But the government needs to provide an alternative to the people; something as reliable as gold, it they manage to put gold back into the financial intermediary system.  There is also the chance that things may get corrected indigenously.  The use of gold for investment purposes is increasing, while the consumption trend seems to be falling.  If this pattern continues, investors will try and look for the next best valuable asset.  Madhusudan Daga, a well-known gold analyst claims that silver seems to have more bullish prospects than gold.  If people slowly switch over to other assets, gold demand may automatically fall.

            So will gold in India lose its sheen? - A few carats here and there perhaps, but nothing more; at least not anytime soon.

Anjana V. Logan

IIIrd Year, B.A. Economics
10/UECA/002