The surge in the domestic demand for gold has continued unabated even when gold prices are going through the roof and new records are becoming the order of the day. With very little of it mined within the country, India has been a massive importer of the precious metal. Last year (2011-12), imports aggregated 1067 tonnes at a value of $60 billion, sharply higher than the $40 billion spent on gold imports the previous year. The bulk of the demand within the country comes from households, both for jewellery making and — increasingly — for investment. In fact, the demand for gold bars and coins has grown tremendously in recent years while the tradition of ornament making has continued to spur gold demand. Of the several reasons attributed to the high demand, a few are prosaic: gold, in a standardised form as bar or coin, is available more freely than ever before, sold even through bank branches. However, it is the realisation that gold as an investment product can consistently beat almost all other normal avenues such as bank deposits and shares — both in terms of appreciation and as a hedge against inflation — that is behind the phenomenal spurt in demand. The macroeconomic implications of this development are huge and although quite apparent to policymakers for a while, are only now beginning to engage their serious attention.

An obvious consequence of the inelastic nature of imports of gold — and, of course, energy products — has been the burgeoning import bill and consequent widening of the trade imbalance. It is a big challenge to reduce the current account deficit, which was at a record 4.2 per cent of the GDP in March, to more acceptable levels. Moderating gold imports through fiscal or administrative measures is not a viable option for an economy that is integrating fast with the rest of the world. Past experience suggests that illicit channels and hawala trading will emerge in the event of a clampdown. Another deleterious consequence of the preference for physical gold has been the sharp reduction in household financial savings, which are vitally needed for the industrial economy. An interesting idea recently suggested by RBI Deputy Governor Subir Gokarn of popularising “paper gold” — financial savings instruments which are backed by gold — is worth pursuing immediately. Long available in centres like Singapore, these products in effect call upon banks to buy and sell gold at market determined prices so that their customers can enjoy all the benefits of gold investment without the hassles of storing it physically. The craze for physical gold will hopefully come down then.