Will Curbing Gold Imports Save the Indian Economy?

June 23, 2012 at 18:06


“An inch of time is an inch of gold, but you can’t buy that inch of time with an inch of gold.” Is this Chinese proverb proving correct in the case of Indians who invest in the yellow metal for good times tomorrow? Or is the craze for the glittering object really ruining the country’s economy?

Time and again the Indian government, economists, and experts have ridiculed the people’s obsession with gold and pointed out the need to curtail imports of the yellow metal to reduce the nation’s trade deficit.

Indians have an irresistible temptation to buy gold — either as ornaments or as investment. Their obsession with the gold jewelry has roots in their culture, tradition, and in the economic realities in the rural and grassroots levels of society. As an investment, gold has been an easier bet to hedge against inflation and other risks. Indians have been buying and trading in gold since time immemorial, and they continue to buy even now, when it is more expensive than ever.

The government and experts believe that high gold imports are fatal to the economy and Indians should stop investing in gold. They say this would solve India’s economic problems, erase the current account deficit, appreciate the rupee, and boost growth. They say the country’s balance of payments is negative because of gold import.
“Quantum of import of gold … is a clear indication that a large section of community … wants investment in a dead asset only with expectation that the value would appreciate,” Finance Minister Pranab Mukherjee said at a function in Mumbai last week. He added, “There is a need to spread financial literacy to encourage people to invest in market instruments” and to dissuade them from investing in gold.

The government believes that India’s common people can easily save the country’s faltering economy by sacrificing their passion for gold.

However, the people who have spent their fortunes on gold and a section of analysts have a different point of view. They say that though gold imports affect the country’s balance-of-payments position in the short term, India’s gold reserves will benefit the people and the country in the longer run. They feel that there is no justification for saying that gold is an idle asset. “From the investors’ point of view, gold is not an idle asset. When it is appreciating, it is not a dead asset for the holder,” says Jayesh Nathwani of FXWire.

To understand both the standpoints, one needs to understand what gold means for Indians and the cultural and economic reasons associated with this:

– India is the world’s largest importer of gold. India accounts for nearly a third of total world demand for gold. India’s gold imports were higher than those of 12 of its states’ gross state domestic products in the year 2010-11.

– Gold’s share of the total import bill of the country has gone up from 8.1 percent in 2001-02 to 9.6 percent in 2010-11. The average rate of growth in gold imports in the last three years was 26.8 percent. At this rate, the gold import bill will be approximately $100 billion by 2015-16.

– According to a World Gold Council report, India has a savings rate of about 30 percent, and 10 percent of this is in gold. It says that gold reserves in India, both private and government, were around 20,000 tons at the end of 2011 and are worth roughly Rs 54 lakh crore, which is 60 percent of the nominal GDP of India in 2011-12.

– Gold import value for the year 2010-11 was higher than the budget-estimated expenditure on urban development, housing, and family welfare for the year 2010-11.

– According to the gold council report, gold jewelry accounted for about 75 percent of total Indian gold demand in 2009, the remainder being investment (23 percent) and decorative and industrial use (2 percent).

– Demand for gold in India is not dependent on international prices but on seasonal demands in the country, like weddings and festivals. So people tend to buy gold whatever may be the price in these seasons.

Gold is a part and parcel of India’s culture and traditions. As money, jewelry, status symbol, and investment, gold has played a crucial role in the lives of Indians for centuries. A family’s wealth was determined by the gold and land it had. Gold is considered “Lakshmi,” the Hindu goddess of wealth, and a symbol of prosperity.

Traditionally and as a religious practice, an Indian woman wears ornaments throughout her life. Gold is her favorite jewelry. Normally, from childhood to the end of her life, gold adorns her in several forms depending on her wealth and status. Though the trend is tilted toward platinum and white gold in recent times among the urban elite, for middle- and lower-class families, jewelry means only gold.

Nothing could replace gold’s stature and importance in the Indian society. In south India the first food a newborn consumes will include gold. According to the tradition, the elder family member will make a paste of a local herb and a minute amount of gold and feed the baby. This is believed to bring wealth and prosperity to the baby.

Gold is also part of the religious practices at homes and temples. In several states the yellow metal is worshipped as a symbol of Lakshmi and wealth.

No wedding is complete without gold, and gold ornaments are exchanged during the wedding ceremony, no matter which religion the bride and groom belong to. Mangalsutra — a neck chain with a mandatory gold pendant — is tied by the groom to the bride during the ceremony. Apart from this, Indian brides are normally decked in gold during their weddings. Though dowry is banned in India, it still exists in practice and gold is the most common form of dowry given to the daughters at their wedding.

The “Akshaya Trithiya” is an auspicious day in the Hindu calendar to buy gold. Devotees celebrate this day (usually in April) by buying gold. In recent years this festival became highly commercialized as the jewelers started promoting sales with discounts. Gold ornaments worth millions of rupees are purchased across the country in this one-day festival.

The importance of gold in the Indian society lies in its money, investment, and risk aversion quotient. Traditionally, gold was the unit of currency. In India there is no difference between rural and urban or rich and poor when it comes to investing in gold. Irrespective of the caste and creed, gold is considered the most tangible form of investment by the people.

Gold remains the easiest asset and investment for the rural poor because of its availability and liquidity. About 60 percent of India’s gold demand is from rural areas.

It is their best tool for risk aversion and to hedge inflation and is their insurance against losses. It is also linked to the rural economy and the agricultural and trade sector. Farmers buy gold after the harvest as an investment. They often sell or pawn gold during the farming season to meet their expenses. This helps them insulate themselves from the claws of rural creditors who charge exorbitant interest on money borrowings.

Rural and urban middle- and lower-class income groups use their investment in gold they made over time to raise money for weddings and renovation of houses and to meet unforeseen expenses, either by selling it or pawning it.

So India’s demand for gold is seasonal and dependent on domestic factors, not on international factors and prices. Gold purchases go high during harvest, wedding, and festival seasons and come down during the monsoon season.

The economists, worried about India’s current account deficit, argue that Indians are importing gold when gold prices are too high in the international market. Since India depends on imports to meet more than 80 percent of its gold requirements and gold as a commodity on its own, it doesn’t add much to the economic productivity. “We have to pay in dollars to buy gold. A huge part of our forex resources, which could have been used to import productive goods, are wasted on it,” says Mangalore-based economy expert Jayadeva Prasad Moleyar.

“Most of gold is in the form of ornaments with the private people in households or is piled in bank lockers most of the time. Gold doesn’t have economic value; it has only emotional value. And considering the heavy pressure its puts on imports, it is an investment better avoided,” Jayadeva added.

Experts also warn that it is unscientific to buy gold at current high prices that are showing signs of declining. They also argue that money that gets wasted in gold should be used for productive purposes in the country, considering the poverty and lack of social infrastructure in India.

But other experts and common people don’t agree. They argue that the theory that gold is an idle investment is wrong. “There was a time when gold was used mainly for jewelry. But now all over the world the trend has changed and gold is an investment option. All over the globe, asset managers and funds are holding gold as an investment tool. Even in India people depend on gold to hedge inflation,” Jayesh says.

Unlike international investors and lenders who invest in markets and trade, most Indian investors in gold aim at long-term benefits and hence they can hedge the short-term price volatility in the price of gold.

They also opine that the government and financial experts who want to reduce gold imports are not considering that gold is the best and least risky investment tool to cope with inflation.

If the government wants to reduce investment in gold, then it should provide the people with an alternative. But there is no alternative to gold now. For the rural people, who are the greatest consumers of gold, bank deposits and real estate are the only investment options easily accessible. As the inflation is higher than nterest rates, bank deposits are unattractive. Real estate prices have skyrocketed even in rural areas, making it difficult for the middle class and poor people to invest in.

People blame bad governance for the trade deficit in the country and opine that instead of attempting to change the centuries-old obsession of the people, the government should try to reduce inflation to save the economy. “Why does the government tell people to save the economy when it is the government’s duty to do it? Why can’t they take steps to improve exports to solve the trade deficit rather than curtailing imports?” asks Jayashree Chakkere, a lecturer in Bangalore.

Considering that the cultural affinity for gold has roots in its ancient history, convincing the people not to buy gold looks impossible.

“When a marriage happens we need gold, for both bride and groom. How can I marry off my daughter without giving her any gold? Even by borrowing money I will have to buy gold for her marriage. Though it is a burden on me, I am sure it will help her in bad times,” says K. Narayan, a farmer in south Indian state of Kerala.

Economists are aware of the difficulty in dissuading people from buying gold. In the past the government tried to regulate gold prices by controlling its supply, limiting supply and increasing tariffs. Until the mid-1960s, the government had tight control over gold transactions as it barred the manufacturing of gold ornaments with more than 14 carats of purity. Even in the last budget, the government raised taxes on gold.

But experts feel that raising taxes on gold will not be any help as it will lead only to higher prices in the domestic market. Due to social factors, people cannot avoid buying gold and a rise in price will only cause gold smuggling, black-market trade, and hawala transactions, as happened in Vietnam when the government imposed a ban on gold imports.

“India has to live with gold imports. Gold imports cannot be banned, as it is citizen’s fundamental right to buy gold. Further, any such measure will increase anti-social activities like smuggling. The government can only request citizens not to buy. But no one will listen to the government. Though gold importing hurts the economy, it is not the only thing that is blocking growth or depreciating the rupee. The government should look into policy issues and improve exports. Even global issues like the euro-zone problems affect the economy. Reducing gold imports to correct the balance-of-payments problem is a temporary solution,” Jayadeva says.

“The government is resorting to a short-term approach. It has increased the tax on gold from 1 percent to 4 percent and is successful in reducing imports by roughly 30-35 percent. It has affected business badly. The notion that gold is non-productive is wrong. When millions of people use it as a security and investment, it cannot be non-productive. Moreover, the government that asks the people not to buy gold itself purchased around 200 tons of gold recently,” says S. Venkatesh Babu, a wholesale bullion importer and president of the Jewelers Association of Karnataka.

Venkatesh says it is better for the government to improve its policies and governance before passing the buck to the common man. “The government should bring in the right reforms and economic policy to solve the economic crisis rather than controlling bullion imports,” he adds.

So the government’s efforts to dissuade the people from investing in the yellow metal may not work in India since it appears that Indians feel that an inch of gold can buy an inch of good time in future.