A Glittering Risk

Gold must not glisten so much so that it makes Indian economy lose its already fading shine. Rising inclination towards gold investment among Indian populace is a cause of serious trouble for the country. It is one of the potential factors behind ballooning current account deficit, which has widened to an all time high of $22.3 billion, or 5.4% of gross domestic product, in the July-September quarter. Current account deficit (CAD) is measured by the difference between a country's exports of goods, services and transfers and total imports within a time period.

Reserve Bank of India, in its recent Financial Stability Report, showed concern over increasing gold imports. As per its draft report “Gold imports have continued to be high and have accounted for, on an average, over two-thirds of the CAD during the last three years. While India’s share in international trade is less than 2 per cent and that in world GDP is less than 6 per cent in Purchasing Power Parity terms, it accounts for a quarter of world demand for gold.”

The investment sentiment in the economy is at its all time low. High inflation is robbing returns on bank savings while mutual funds and equity are not offering attractive returns either. Gold seems to be the safest option for people to invest their hard-earned money. It is a global phenomenon as people tend to go for gold because it provides them a sure hedge against growing inflation and in an insecure economic environment. Only difference is that their gold trading is paper-based unlike ours. Recently SBI proposed an idea of virtual trading of gold instead that of physical. Gold-linked financial instruments, gold bonds etc must be introduced which yield similar returns as this yellow metal does in physical form. Such paper based gold trading might reduce the problem of physical possession of gold which leads to higher import of gold.

According to the most recent available data from the World Gold Council, India's gold demand during the January-September period of 2012 was 607.6 metric tons, down 24% from a year earlier. It could happen because Govt. had doubled the customs duty on standard gold bars to 4%, and non-standard gold bars was doubled to 10%. But a closer data study reveals that gold imports did fall to 131 tons in the April-June quarter but again rose 9% to 223.1 tons in the July-September quarter. A sharp recovery in Q3 is also likely due to peak festival and wedding season buying. Hence Govt. effort of increasing import duties on gold in the current fiscal year, eventually, bore no fruits.  Yet Finance Minister P. Chidambaram again intends to resort to making gold imports costlier. He must also keep in mind that expensive retail price of gold might lead to smuggling of the same. Govt has also asked gold import agencies such as MMTC and STC to lower the volume and value of gold imports.

Gold loans disbursed by banks and other Non Banking Financial Companies (NBFCs) pose a threat to financial stability of banks in India. They lend borrowed cash from banks to people in exchange of gold. RBI says that the bank-debt of these gold-loans companies have increased by 200% over the period of one year. Indian banks will be in trouble if ever NBFCs falter in the wake of volatility in gold price. As per RBI guidelines, these companies can only provide 60% of loan against the value of collateral gold.

Predictions are against any betterment of economic condition in year 2013. This negative sentiment will buttress the trend of gold investment further because real profit through any other savings policies is meager given lower interest rates and inflation. Govt. must understand that bumping up import duties on gold import is not a solution. He would do well if he tries to drift people’s attention away from this yellow metal by offering equally valuable financial products and inflation-indexed policies. Higher gold import is actually not the only problem. Recycling of gold scrap, huge stock of idle gold which is highest in the country and gold-smuggling are few other challenges needing immediate concern. It’s high time that Govt. pursues a viable gold policy.