Can policy actions by themselves reduce the demand for gold in India? The craving for gold, both as jewellery as well as an investment option, has reached such dimensions that the government and the Reserve Bank of India (RBI) are working in tandem to moderate the domestic demand. The point has been made several times before, including by the Finance Minister, P. Chidambaram, recently that the demand for gold has been such that the macro economy has been adversely impacted. The widening of the trade deficit and with it the current account deficit (CAD) is one obvious fall-out. Recently, the CAD seems spinning out of control to touch 5.2 per cent of gross domestic product (GDP) during the second quarter (July-September of 2012-13). Gold and petroleum imports have been behind the high trade imbalance. Both have remained inelastic. Policy-makers have had very limited success in moderating the imports of both.

A working group constituted by the RBI to study the issues connected with gold and gold loans by non-banking finance companies (NBFCs) has just submitted its report (see RBI’s website). Apart from addressing the key question as to whether the large gold imports pose a threat to macro-economic stability, the group has sought to examine whether there are any systemic issues arising out of the inter-connectedness of some banks and gold loans of NBFCs.

Necessary moderation

Moderation of gold imports is necessary for the sake of external sector’s stability. However, in the past, gold imports have not strictly been amenable to policy changes. They have also been price inelastic for a variety of reasons. The banking system has a definite role to play although its share of canalised gold imports has been declining.

One promising remedy would be “financialisation” of gold, both the imported component as well as the domestic stock. Banks and institutions need to introduce attractive savings packages based on gold. Simultaneously, alternative avenues for investment should be made to provide a real rate of return that is higher than what obtains now. Only then can domestic consumers be weaned away, at least partially, from their craving for gold.

Simultaneously, there is a need to monetise the domestic stock of gold. Gold loans are already popular. There is a need to refashion them to safeguard the interests of consumers as well as banks that disburse them directly or through refinancing of NBFCs. Banks can consider accepting gold as collateral for their regular loans.

An opposite view is that since the easy availability of gold loans is a principal factor behind the increased demand for gold, policy measures must aim at reining in such loans. Given the certain appreciation of gold, it pays for even the average person to pledge his or her gold to buy more gold and repeat the cycle. A decent return of around 15 per cent is assured, say experts. That, of course, is an unproductive use of gold.

Obviously, the group is hard-pressed to find “real” solutions to the problem. There is really no magic bullet. In the past, neither higher duty on gold imports nor any other form of restraint has been effective. The Finance Minister has hinted that the duty might be increased. It is doubtful whether that will reduce the demand. Gold trade might shift underground and adopt other illegal channels. India’s jewellery industry is vast and flourishing. Any move to curtail imports of gold will adversely affect the prospects of an industry that has immense export potential as well.

There are very few recommendations of the expert group that might be considered original or novel. The ones that can be implemented need to be taken up. Products such as gold accumulation plan, gold-linked account, modified gold deposit and gold deposit have been suggested by the committee. Most of these obtain in other principal ‘gold’ centres such as Singapore. Basically, these involve an amalgam of the features of existing deposit schemes (example recurring deposit) with the features of gold trading. It goes without saying that banks and others who will operate these schemes should be equipped to handle gold as an investment. While popularising such schemes it must be ensured that the intermediation (bank) charges are kept low and publicised as such.

Breaking status quo

Ultimately, it is a question also of breaking the strong emotional and cultural links that owning gold has in this country. Long before this current craze, in States such as Andhra Pradesh, agricultural gold loans have been extremely popular. In times of crop failures or agrarian distress, gold loans were taken to tide over the crisis. Gold in the hands of individual households might not be large but they came in handy during difficult times. By no stretch of imagination can this be considered speculative demand for gold. It would be good, therefore, if policy-makers recognise the different facets of the current gold craze. From a macro-economic point of view, there is really no permanent solution, except by winning the battle over inflation, and, equally importantly, convincing ordinary people that their investments in conventional bank deposits as well as in those backed by gold yield a real return.

narasimhan.crl@thehindu.co.in