Credit: Shutterstock photoThere is no denying the fact that Indians love gold. Gold is deep-seated in the psychology of the Indian society due to its sense of security strongly attached to it. Gold has, in fact, remained the natural mode of saving and investing through generations. Whether rich or poor, you will find some glitter in most portfolios. However, this psyche has not been favorable from the policy-makers’ perspective as they struggle with ways to curb the import of the yellow metal to keep India’s current account deficit under check.
The economics of gold in India is interesting. The import of the precious metal was banned into the country until the early 1990’s. The obvious result: the price of gold in India was higher than elsewhere, a situation well-exploited by smugglers and lobbyists. The smuggling of gold was very active during this time, something commonly reflected in the Bollywood movies of that era.
As India adopted policies of liberalization, the ban on gold imports was eventually scrapped. But the government has been time and again imposing quotas or restrictions on the inflow of gold. All of this has not proved good enough as the demand for gold in India continues to soar. As per statistics by the World Gold Council, in the past five years, India has imported roughly 4,500 tons of gold, averaging to about 895 tons per year.
India’s robust demand with a weak domestic supply results in huge dependence on import of gold. During 2014, India’s demand for gold was at 987 tons while a mere 102.8 tons was supplied domestically. By comparison, China’s demand was 1,283 tons while its domestic supply was 582.9 tons. Thus while China imported 700.1 tons of gold, India imports were at 884.2 tons. Turkey and Thailand also had a shortage of supply and imported 86.2 tons and 131.8 tons of gold, respectively. The situation in the U.S. was the opposite with a surplus supply of 125.9 tons. The import of gold results in huge outflow of foreign exchange which adds burden to India’s current account deficit (CAD), a persistent problem the government struggles with.
The allure for gold has made it a difficult commodity to tackle - not only is the demand for gold, its price is inelastic to quite an extent, meaning that the rise in gold prices does not affect its demand that much, but it also means that people are even less interested in exploring other financial assets. Despite the fact that the saving rate in India remains high, the formal financial system is not a huge beneficiary.
Yet Another Attempt
While it’s never been easy to formulate an effective policy pertaining to gold, the government continues to try; the latest one being the launch of gold-related schemes by the Modi government. The Indian household is believed to hold around 22,000 tons of gold with an estimated value exceeding $1 trillion. The government through its new schemes is looking to unlock this potential and bring it into circulation to meet the domestic demand for gold, thereby reducing the import burden. This would provide some relief to the government’s burgeoning current account deficit.
The first is the gold monetisation scheme (GMS), which would replace the existing Gold Deposit Scheme. Under the new scheme, a gold deposit with a bank will be opened for the amount of gold that has been tested and certified by an accredited center. The customer will have the choice to decide the tenure of the scheme and on maturity, the gold value will be redeemed at an interest rate of up to 2.5% per annum. The Gold Monetisation Scheme will be linked to the Gold Metal Scheme to bring the gold deposits back into circulation as this gold will cater to the demands of jewelery manufacturers, who would further sell it to customers. It will work in a way that is similar to how regular money is created by the banking system.
The second scheme is the Gold Sovereign Bond Scheme under which investors can park money in papers backed by gold for a tenure of 5-7 years with an interest of 2.75% per annum. These papers will be tradable and can be used as collateral for taking loans. As per estimates, approximately 300 tons of physical good is purchased each year for investment purpose which comes mostly via imports. The gold-backed paper can potentially help in avoiding direct investment in physical bars and coins, thereby reducing gold imports to some extent.
The initiative to make the gold present within India more mobile is a task easier said than done. Out of the two schemes, the Gold Bonds should be able to tap the resources more easily as it requires conversion of cash into bonds and back. While the Gold Monetisation Scheme requires gold in pure melted form, which can dissuade people as they may not be ready to part with jewelry that has been passed on through generations or had been bought for special occasions.
Final Word
The process has many obstacles in its way, the mindset of a typical household is hard to change, and the interest rates offered may not be lucrative enough. Although with the amount of idle gold lying within the country, even partial success could provide relief to India’s current account deficit and boost the economy. But even that partial success may not come easily.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
