Glittery Gold Jittery Government

Instead of cynically hiking import duty, Govt. would do well if it paves way for either virtual trading of gold or it should launch gold-indexed bonds instead of inflation indexed bonds.

Unmindful of its earlier failed efforts of controlling gold-import and discouraging its demand, Govt. once again resorted to the same trick by ratcheting up gold import duty to 8% from 6% (fourth hike within two years) disregarding the speculative undertone it might generate. Reserve Bank of India (RBI), in the vein of Govt., levied more stringent restrictions on banks to import gold and provide loans to public. Given the ballooning Current Account Deficit and badly depreciating rupee against dollar, curbing gold purchase seems the only viable step to Govt. to tame the imbalance of payment but it is highly unlikely if it would discourage the people to invest in gold as its being the safe and lucrative haven is a widely popular notion in the country challenging which is a tough nut to crack.

The unprecedented fall in gold prices in the month of April somewhat provided sense of relief to Government but unfortunately the impact of price-fall substantially got counterbalanced by surge in demand due to wedding and festival season in the country with gold imports touching 162 tonnes in May. Rising gold imports also pushed the trade deficit to $17.7 billion in April. Further trouble befell with the consistent depreciation of rupee which has now surpassed 57 against dollar bricking the prospect of even more widening CAD leading to even higher inflation which is already at an intolerant level.

It is in this backdrop that the Govt. has hiked gold import duty and RBI asked banks and nominated agencies to not import gold on a consignment basis for domestic use. Also, RBI disallowed import of gold on credit and advised banks to dissuade people from parking their savings in this glittery metal. Co-operative banks have been told to only lend against gold ornaments, gold jewellery and gold coins weighing up to 50 grams, amount of which must be within the Board approved limit. Though these measures might serve the purpose of Govt. in the shorter term but considering the fact that steps of similar kind have already been exercised earlier for no avail, it would not provide a medium term solution let alone long-term. The vicious cycle of yawning CAD, rising inflation, falling rupee and sputtering growth is the result of structural deficiencies but Govt. is hell-bent to put onus on Indian’s lure of Gold and fuel subsidies.

Considering the dearth of inflation-hedged investment options, Govt. has though launched the first tranche of Inflation Indexed Bonds but the fact that its coupon rate and principal amount are indexed against Wholesale Price Inflation (WPI) not Consumer Price Inflation (CPI), returns on these bonds would not be much profitable as its latter not former which directly affects the consumers. On the other hand Gold, despite its price-fall provides favourable return against rising inflation. Also, the ease of purchase, as against IIBs for which one has to go through the tedious system of opening bank accounts, filling up litany of forms, understanding complex formula etc, makes it handy and an obvious choice for investors over any other financial instruments.

Gold-frenzy is a global phenomenon. Only difference is that Government worldwide has channelled this frenzy into paper-based trading of Gold. Given this, instead of cynically hiking import duty, Govt. would do well if it paves way for either virtual trading of gold or it should launch gold-indexed bonds instead of IIBs. It is well past time to understand that it doesn’t matter how many hurdles or challenges being put up in the gold-game, Indians will bravely and enthusiastically sustain but would not give up till the end.

Bond against Inflation

With an ever increasing import of gold and nose-diving Rupee, government is forced to reckon with the idea of providing a hedge  to investors against  the return eating monster i.e. inflation.  Gold has become  only solace for investors to park their surplus as every other financial instrument has surrendered before the might of stubborn double digit Inflation. Reserve bank of India is now seriously considering to open the window of Inflation Index bonds- a  debt instrument  offering protection against high inflation.

India’s fresh lure of gold is predominantly driven by financial investment needs. Gold imports in India have risen to its peak and resulted in a panicky level of current account deficit and weak rupee resultantly. Apart form making gold imports costlier govt wants to divert the gold buying frenzy towards a befitting investment alternative. Inflation Indexed bond comes as an appropriate option in this context.

Inflation indexed bonds are those overall return on which is adjusted against increasing inflation. Inflation indexed bonds are popular and successful in USA, UK, Australia, Sweden and many other developed countries.  India introduced a derivative of the same i.e. capital indexed bonds earlier in 1997, then again in 2004 but the bond failed to garner attention as only principal amount was indexed against inflation not the coupon rate, consequently the real returns remained unprotected from inflation. RBI is again considering for a new avatar of IIB amid a couple of ifs and buts.

A robust inflation index is the most important pre-requisite for IIBs. India has several inflation measuring indices, ranging from wholesale to retail Inflation. It is still not clear which one would be used for pegging return on IIB . That IIB may disrupt the G-sec market is also a prevailing concern for the central bank. Government securities are the major source of govt  borrowings.  Fixed interest of G-sec will surely make the former i.e. IIBs a preferable investment option over the latter.

The timing of issuing IIBs is also a point to ponder.  Govt or issuer has to shell out  more money during the high inflation period. Considerate thought must also be given to defining tax rate on IIBs returns. Higher taxation on the same will eat into the vitals of returns.  It would be ideally prudent that IIBs are left tax-exempted otherwise it will be of no significance to investors.

IIBs are a welcome concept but the current challenge is to tame the lure of gold to contain higher gold imports. Given the policy bottlenecks of IIBs, it seems doubtful if it can provide equivalent benefit as gold does. Returns on gold is already three times higher than inflation rate with the prospect of spurring further. Gold-indexed bonds , yielding similar returns as this metal does in physical form, could become a better idea in the short run. A cornucopia of IIB and GIB  may do a lot better in the given situation of Indian economy.