Burgeoning gold imports to meet the seemingly insatiable appetite for the precious metal by Indian consumers, though not new, have grown to such major dimensions recently that policy-makers are forced to take note. A check on gold imports by way of physical controls over imports or through fiscal measures to restrain consumption (such as through a special consumption tax) are impractical, and out of question. Policy-makers are, therefore, forced to look at ways of harnessing this phenomenon — of unbridled gold imports and consumption — in ways that will benefit the economy while moderating its demand internally.
There are at least two important macro-economic dimensions to this phenomenon of ever-rising gold imports even in the face of record gold prices.
One, the immediate impact is on the external economy as gold and energy imports contribute to a widening of the trade deficit, and, hence, the current account deficit, which was at a record high of 4.2 per cent on March 31. According to the World Gold Council, for April-June 2012, gold imports stood at 181.3 tonnes.
The macro-economic problems associated with running such a high current account deficit have been highlighted several times before by many official reports, including those of the Reserve Bank of India (RBI). Needless to add, the twin deficits, the high fiscal is the other one, are a major threat to economic stability.
Two, the lure for gold among consumers has a direct impact on the quantum of financial savings by households.
According to the Economic Advisory Council of the Prime Minister (PMEAC) (in its flagship publication Economic Outlook 2012-13 released in August), net financial savings of households available for use by the rest of the economy fell below 11.6 per cent of gross domestic product (GDP) in 2007-08 to 10 per cent in 2010-11 and likely to go below 9 per cent in 2011-12. (Net financial savings are calculated by deducting financial liabilities such as mortgage and personal loans from gross financial savings.
Gross financial savings are measured as an increase in gross financial assets.) At around the same time as the Economic Outlook, the RBI released data which were even less upbeat: household financial savings fell to 7.8 per cent in 2011-12, the lowest since 1989-90. During the preceding three years, it averaged 11 per cent.
Certain broad conclusions are possible from the above data: (1) when the economy is faring well, households tend to put more money in financial savings instruments. The stock market is likely to be bullish and mutual funds will also look attractive.
(2) However, when the cycle turns and the environment is less optimistic, households tend to do the reverse — withdraw from organised financial savings such as bank deposits, shares and mutual funds. The availability of household savings for the industrial economy gets reduced.
(3) It is in that context that the significance of gold as an investment avenue and as a hedge against inflation becomes apparent.
Households withdraw money from financial savings, and, to a large extent, invest in gold, property and other physical assets. This is after providing for the higher living expenses that are characteristic of high inflation. Inflation outlook and hardened inflation expectations — prices of essentials are unlikely to come down — play a large role in apportioning available savings of households.
In that scenario, gold has emerged as a clear winner. In India, as in many other countries, the lure for gold is unmistakeable. The surge is partly explained by increased availability of gold and the growing realisation of its potential as an investment opportunity, especially in pessimistic times.
The task before the government is to find ways to integrate the physical market for gold with the financial market. Already this is happening.
The oldest and even now the most popular one is the gold loan, where banks/NBFCs (non-banking finance companies) dispense money on the pledge of gold /gold jewellery.
As propagated with great success by several Kerala-based NBFCs, gold loans have come under the scrutiny of the RBI, which has imposed some stringent conditions to safeguard the borrowers’ interests.
Exchange-traded funds (ETFs) with gold as the underlying assets are mutual funds listed on the stock exchange. Many such ETFs have been launched recently, and are flourishing.
Obviously, many more new products are necessary for a more complete integration that alone will make an impact on gold consumption. RBI Deputy Governor Gokarn made out a persuasive case recently for new gold-backed financial products such as modified gold deposits and gold accumulation plans besides gold-linked accounts and pension products.
Many of these are popular in important financial centres such as Singapore. The average citizen in those places is better informed about the financial markets — exchange rates, gold prices and so on. That would make it easier for the authorities to popularise new innovative products, linking gold to the banking system.
In India, there is a tradition of possessing gold, especially as jewellery.
There is, however, far less understanding of how financial markets function. In that context, innovation would appear to be difficult, but there is no doubt at all that its time has come.