In 1991 the then economically beleaguered government of India was about to pledge gold to IMF for aversion of Balance of payments crisis, which was reduced to such an extent that India had finances which barely could last for 3 weeks. Yellow metal was proving to be a savior at that time but currently increasing imports of yellow metal is proving to be a nightmare for government officials in India.
According to WGC’s Gold demand trends of Q3 2012 India and china together consume 54% of the World gold demand. India accounted to 30% of the total Gold demand whereas this was 23% in Q3 2011. The demand growth is defying the increased prices of the gold from ~$ 1000/Oz to ~$1700 wrt Q3 2009.
The demand supply gap in India is very huge where; India’s production stands merely 2.2 tones whereas the demand for the gold is 223.1 tones . In order to satisfy wide gap India needs to import almost its entire requirement from outside of the country.
During the last ten years from 2000-01 to 2010-11 Gold & Silver has climbed to 2nd spot into imports from the 3rd spot just after the crude oil. Consumers buy gold and store them in lockers or convert the bars/coins into jewelry, in both cases the productive benefits to economy are not yielded as the amount which is used to buy gold gets locked.
More importantly the FOREX reserves used to buy gold reduces the availability of the funds to purchase other important commodities/capital goods which when imported will help to increase the productivity and thereby contributing to Indian economic growth.
1. Hedge against inflation
2. Instant liquidity
3. Cultural affinity and high emotional attachment
4. Widely accepted medium of exchange
5. Store of value.
The current account deficit has been rising on the back of record trade deficits, which in October jumped to 12 year high of USD 21 billion majorly due to crude and gold imports. The increasing prices of gold in last 3 years are compounding the issue for government as they have to shell out more reserves to satisfy the demand.
Government in the recent times tried to curb the demand by various ways like:
1. In last budget 2012-13, government increased the customs duty from 2% to 4 % on standard gold bars . The impact was visible in the economy as the physical demand is expected to reduce to 17 % compared to last year. Still the overall demand remains high.
2. Government also tried to impose tax to the tune of 1 % through jewelers when a consumer buys the gold more than 2 lac. This raised wide protests amongst the jewelers association and was later rolled back .
3. In April, RBI asked banks to reduce the exposure from 10 % to 7. 5 % to single gold loan NBFC’s.
4. RBI also asked banks/NBFC’s to reduce the LTV (Loan to value ratio) from 85-90% to 60%.
In Contrast, investment products awareness like ETF has opened up another venue to invest in precious metal in small denominations. If we see increase in the AUM under gold ETF’s it has been tenfold, from ~ 1000 corers to ~ 10,000 corers’ and increasing in recent years. People are holding the gold in demat form but still the fund houses has to buy physical gold and keep with them as and when investors purchase them.
Another important aspect is that currently huge amount of gold to the tune of ~ 25,000 tones is locked into Indian houses inform of bars and jewelry (if we include temples then the estimate goes to staggering ~85,000 tons), if the existing gold can be brought into the system and then revolved, this will reduce the physical demand of gold in form of import and will not hurt the investor sentiment of gold investing.
Government needs to strike a balance between gold investment and reducing the physical import of Gold. RBI has set up a committee under KUB Rao to look into the issues and come up with the solutions on this.
The options which government is mulling to curb the import and thereby reducing the impact on Current account deficit are as below:
1. Gold Deposit scheme: under this scheme, investors have to surrender the gold to banks, which will give interest as well as return on the deposited gold. However the gold will not be given back to the investors/consumers.
2. Gold Linked account: With the help of the investors’ money banks will be hedging in the international market for the gold but in this case investors are not going to get the interest on the amount. On the expiration of the scheme the investors will get the amount which is equal to the return on the gold prices.
3. Gold accumulation Plan: Investors will get a chance to have recurring deposit thorough banks in gold. Here investors can receive delivery of Gold. Banks are going to hedge in futures market with the investors’ money.
4. Gold Pension plan: this will work in same manner as reverse mortgage plan and RBI is thinking to rope insurance companies and banks into this.
5. Gold Bonds: to issue bonds against the gold bars/coins and jewelry, and then give minimal interest on the gold such that it satisfies the need of the investors and reduced the physical import.
The last option of gold bonds was tested by government in mid-1960 but was not so successful at that point of time due to less demand and gap between demand and supply. Today the scenario is different as 85% of the imported gold is accounted. If banks give just 1 or 2% interest on the ideal asset and if government with the sincere efforts tries to rope in ~1000 to ~1500 tons of gold back in system then this will drastically reduce the import requirements.
Apart from the above another option which is not preferable is to ban the imports on gold but this is not a viable option as this will increase smuggling of the commodity as per C Rangrajan, chairman PMEAC. He also adds that last year the high import on gold was due to the fact that inflation was very high in the Indian economy and people view investment in gold as a hedge for this. Once the inflation subsides the demand for gold is going to come down.
Not to forget that we have so many regulatory hurdles in implementing the above schemes/ideas as government has to choke out the exact blue prints and tax (Local duties, customs, VAT, personal tax)related consequences on those.
