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Thursday, December 6, 2012

Gold imports: Let us not make things murkier once again

Yes, gold causes nightmares, of course, not to you and me —the aam admi—but to the managers of the national macroeconomic fundamentals.

India, according to the World Gold Council, is the largest consumer of gold, accounting for 22% of the world’s jewelry. Reports indicate that ever since the Gold Control Act was repealed in 1992, the demand for gold has grown at a compounded annual growth rate of 4.7%. This has led to an accumulation of gold that is valued today around a $1 trillion. 

The most disturbing element of this accumulation is, 90% it is met through imports. During the fiscal 2011-12, gold imports touched almost 2% of our GDP, while its share in the total imports stood at 9%. Indeed, gold is the second largest item of imports, the first being oil. The fallout of it is: India’s widening current account deficit—one estimate states that gold imports equal 75% of our current account deficit.

Notably, the demand for gold has gone up ever since reforms were launched and the economy witnessed an unprecedented growth, as is reflected in the rise in the share of gold in the total import bill of the nation—from 8.1% in 2001-02 to 11.5% in 2011-12. Economists opine that this demand is all set to go up further for reasons galore: one, in today’s inflationary scenario of 9.5% and above, gold acts as a hedge; two, the falling GDP growth rate has made alternative assets like equity and debt less attractive; three, unlike the well-off urban folk, the rural and semi-urban investors have very few options to save other than in gold; and, four, gold has very high social value for Indians, and rising economies will only overemphasize this requirement.

Above all, the ordinary Indian investor considers gold as a highly liquid asset, besides being an asset with less price elasticity vis-à-vis other asset class and hence holds it reverently to meet unexpected exigencies.  On the other hand, returns on gold are found to be “higher than those of the Nifty, one year bank deposits and 10-year government bonds over the last few years.” Another important concern of ordinary savers across the street that policy makers should bear in mind is: bank deposits do not protect savers against inflation, for real interest rates are always found to be near negative as the monetary authorities are more focused on encouraging investments through low-cost credit.

Obviously, all this cumulatively leads to an unbridled demand for gold and gold imports. And this is what is causing nightmares to the finance minister and the governor of Reserve Bank of India (RBI), for it has resulted in macroeconomic imbalances, particularly balance of payments. Looking at the Indians’ craving for gold and the pressure that its import is exerting  on the current account, RBI is considering introducing four gold-related instruments—modified gold deposit scheme that accepts gold as deposit from the public for a definite period and pays interest in the form of gold on maturity; gold-linked account, a non-interest bearing account wherein gold is purchased and kept abroad, of course, duly hedged and sold on maturity and equivalent cash paid to the depositor; gold accumulation plan, which is like a systemic investment plan of any MF wherein gold is purchased in small quantities at regular intervals and physically delivered at the end of the period; and gold pension plan which is like a reverse mortgage facility paying monthly payments to senior citizens—to ease the demand for gold in physical form.

That aside, the Ministry of Finance too is equally agitated by the challenges posed by the supply-demand dynamics of gold to monetary management. The market is also ripe with the speculation that gold imports might be banned. Or, its import might be made prohibitively costly by increasing import duty— import duty has already been raised to 4%. But such measures would be suicidal, for any apparent impediment to meeting the demand for gold from ordinary Indian consumer will immediately be encashed by the smugglers. As C Rangarajan, former governor of RBI, and the present Chairman of the Prime Minister’s Economic Advisory Council, said: “Banning gold imports is a bad idea. If we ban imports, smuggling will go up.” He is also of the opinion that gold imports will come down when inflation settles down. For that matter, looking at the projected growth rate of GDP at 5.5% for fiscal 2013, the gold imports might as well come down from the current year itself.

There is yet another factor that the policy makers have to take note of before jumping to dole out a half-baked way-out to reduce gold imports. Today every Indian can take away $2,00,000 annually in foreign exchange and buy foreign stock or property. Similarly, the corporate are taking away billions of dollars to acquire overseas companies. As against this, if gold imports rise for meeting the demand of domestic savers, there will be hardly any reason to worry, for this asset remains within the country/is used to raise loans for managing small businesses, again within the country. Isn’t it much better than investing in overseas stocks?

In view of these ground realities, what the government should instead do is, as the SBI chief observed, permit banks to buy back the gold coins sold by them to their individual customers, for such repurchase will create good liquidity of the metal. This measure can draw a good quantum of gold for sale owing to the reliability factor associated with banks in terms of evaluation of quality and price offered. As holding of gold in the form of coins/bars for investment purpose has gone up vis-à-vis jewelry in the recent past, this move shall also encourage ‘financialization’ of savings. Incidentally, as at the end FY 2012, the worth of gold holding by Indians is estimated to be around Rs. 2,44,000 crores, and thus any move for its financialization will also help in the growth of GDP. This in turn could ease the pressure on the import of gold. At the same time, savers must be educated to shift to alternate paper investments to gold.

The last but the most important issue which the policy makers should address is, to use the words of the former governor of RBI, Y V Reddy: “If Mercedes-Benzes and aftershave lotions can be imported, why not gold” for enabling aam admi to park their savings in a dollar-denominated asset like gold?  In any case, as Peter Bernstein once said, “Gold, like liquor, satisfies too many needs to survive prohibition.” And it makes great sense not to make things murkier once again.


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