Tackle inflation, not gold Mr FM! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Tackle inflation, not gold Mr FM! 

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In this issue:
» Has Indian economy 'bottomed out'?
» No PSU bank IPOs in 2013
» No more tax hikes for US?
» IMF wants countries to have a bankruptcy regime
» ... and more!

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In recent times, the Finance Ministry and Reserve Bank of India (RBI) have agreed on one thing at least. And that is that gold prices need to be curbed. The Finance Minister has even blamed gold for India's current account deficit problem as well as the falling Rupee. He recently said that if gold imports had been halved; the country's foreign exchange reserves would have gone up by US$ 10.5 bn. But a recent article in Firstpost has stated that the warfare against gold is actually unjustified. And they have given the data to back this up.

It is a known fact that the price of any commodity be it gold or otherwise, depends on international prices. In the period from August 2011 to December 2012, the international price of gold has declined by over 11.9%. During the same period, the price of gold in Indian Rupee terms has gone up by around 9.6%. If this increase in India was driven purely by an increase in domestic demand, then ideally it should have led to an increase in international prices of gold as well. The thing is that the demand for gold internationally outstrips supply. So if there is an increase in demand from a country like India, which is one of the largest importers of gold, then international prices would have gone up. But that did not happen.

Therefore the premise that gold prices in India went up on the back of increased domestic demand should be wrong. So who was responsible for this increase? Let us look at what happened to the Indian Rupee during this time. The value of the rupee depreciated by 19.5% during the same period. This means that the increase in price of gold was actually due to the rupee and not due to demand.

The Indian Rupee has come under pressure due to persistently high inflation in the country and the twin deficit problem. The country's current account deficit has shot up to 5.4% of GDP. At the same time, the fiscal deficit situation has not come under control either. The government has to take immediate steps to tackle issues related to supply chain bottlenecks, inflation, subsidies and the deficits. That is what will help bring rupee under control in the long term. Using gold as a scapegoat for all troubles is just evading the larger picture. Given the data, they should be looking at the other issues rather than figuring out how to kill Indians' inbuilt love affair with gold.

Do you think the government's fight against gold is justified? Share your comments with us or post your views on Facebook page / Google+ page

01:05  Chart of the day
The year 2013 has brought the news of costlier transportation in national capital. After a period of 6 months, IndraPrastha Gas Ltd (IGL), the key supplier of CNG, has revised CNG prices by 4%. Interestingly, since the start of 2012, CNG prices are up by 18%. At this rate, they beat average inflation by a wide margin.

Few years back, with the discovery of Reliance Industries' (RIL) KG DG basin, the domestic gas scenario looked brighter. The gas production from the field was initially forecasted to touch 80 million standard cubic metres per day (mscmd). However, since hitting a peak of 55 mscmd in August 2010, the gas supplies have been consistently falling. The decline has been steep with current production at around one fourth of the target. As such, more and more demand is now being met through the imported gas. Since imported gas is around three times costlier than the domestic gas, the CNG prices are on a rise. With the existing gas pricing policies in the country , there is hardly any incentive with the domestic oil and gas companies to produce gas. Unless the Government gets its act right, the graph will only go up.

Source: Financial Express

The Indian economy has been facing a nagging question over the last few quarters- When will it eventually bottom out? For some time, there were intermittent hints that the economy was on the verge of getting better. But then things ended up getting worse. Now we are in 2013. Are things set to change? As per an article in Livemint, the economy seems to be bottoming out. The HSBC Purchasing Managers' Index is said to be one such indicator. Latest data hints at improvement in factory output and new orders. Moreover, the third quarter earnings (3QFY13) season which is set to commence soon is also expected to give some relief.

Of course, one must not mistake this for a recovery. When we say 'bottoming out', it only means that the worst is over. It usually precedes a recovery. But that doesn't mean that a recovery is in the offing. A lot needs to be done on the policy front before India could go back to its 8-plus per cent growth rate. On the other hand, risks of inflation and unexpected external shocks could send the economy into another slump. So while it is reassuring that the worst might be behind us, it would be too early to celebrate a recovery.

The Indian stock markets were up 26% in 2012. However, the Indian government has not been able to capitalise on the same. The funds raised from divestments have been below par. It hasn't even scratched the surface of the ambitious targets set for the year. Recently the government has ruled out the possibility of any public sector bank coming up with a public offer in the current fiscal. The government will thus have to deploy its own funds in order to recapitalise these banks through a preferential issue. The finance ministry has stated that its aim is to infuse about Rs 159 bn by March end in order to maintain a 58% stake in state run banks. The banks that urgently require capital include Indian Overseas Bank, Central Bank of India and Bank of India. State Bank of India will also be allotted some funds. Basel III continues to be a hurdle for banks. As per the guidelines Indian banks will have to maintain a common equity ratio of 8% and a total capital ratio of at least 11.5%. The Basel III rules will start getting implemented April 2013 onwards. Since capital is expensive and the government is cash strapped, maybe the finance minister's plan of consolidation in the banking space merits some more thought.

The fiscal cliff for the time being was averted when the Republicans agreed to the proposal of increasing taxes on the wealthy. The issue of spending cuts was conveniently postponed. But the Senate Minority Leader Mitch McConnell has once again brought this issue to the fore. He opines that the tax issue is now behind the US. There is no need for more of the same. Instead, the country has a major spending problem and the focus should now be on how to reduce the same.

The Democrats want to increase the debt ceiling. The Republicans, on the other hand, will agree to this only if there are big spending cuts in programs including Medicare healthcare for the elderly and the Social Security pension program. This once again looks like a making of another political gridlock between both the parties. And we will not be surprised if the solution that eventually is decided upon only postpones the problem further rather than resolving it.

How do you think a dispute between two parties could be resolved most amicably? Well, we believe by way of identifying a common set of rules and then analysing which of the two parties have been in violation of the same. But what if there is no rule book that everyone is in agreement with? In that case, none of the parties would be willing to change their stance, indicating that they and they only are right. Something similar happened recently with the country of Argentina and a couple of hedge funds it had taken debt from. While Argentina maintained all along that all its creditors should agree to restructuring of its debt, the hedge funds were simply not impressed. The latter kept insisting for full payment and had their way when a US court ruled in their favour. Now this has created a serious problem?

The victory of hedge funds could mean that debt restructuring would become very difficult in the future. And this could in turn aggravate economic difficulties for a nation in distress. Thus, the need of the hour is a common rulebook in the form of a sovereign debt restructuring mechanism. This is easier said than done though. Approving of the mechanism would effectively mean that an international institution will override bankruptcy proceedings in the member countries. And this could not be acceptable to all countries. But given the seriousness of the situation, something will have to be worked out we believe.

In the meanwhile after opening the day on a positive note, Indian equity markets are now trading below the dotted line. At the time of writing, the Sensex was down by 13 points (0.1%). Barring China and Malaysia the other major Asian markets closed on the day on a negative note.

04:55  Today's Investing Mantra
"To have a true investment, there must be a true margin of safety. And a true margin of safety is one that can be demonstrated by figures, by persuasive reasoning, and by reference to a body of actual experience." - Benjamin Graham
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11 Responses to "Tackle inflation, not gold Mr FM!"


Jan 9, 2013

I agee with your comment that the FM must tackle inflation and not gold.Unfortunately the FM knows nothing about inflation.


kunal desai

Jan 8, 2013

v good



Jan 8, 2013

If each one of us takes a commitment of consuming ONLY 10 liters less of Petrol/Diesel per week, can someone calculate how much we will save on our import bill, whereby we are loosing foreign exchange??


Shalin Mehta

Jan 8, 2013

Yes, I agree with the article by EqM on Gold. Govt's priorities are either wrongly placed OR they know it; but since they can't do much about it, they are thinking of scapegoats and diverting attention from real issue while hoping to get some short term immediate result to show.



Jan 8, 2013

Our and all other Govts. are poor spenders of money. They will never be able to repay what they borrow, ever. So public (especially Indian public) must refrain from giving their hard earned savings to Govt. in form of Bonds, Saving Certificates, etc. Invest in Gold and Land if possible. Hell with the FM!


parimal shah

Jan 7, 2013

Let us ask Mr FM:
How much would our Foreign exchange reserve risen over last 60 years (or even just last 6 years) without the diesel subsidy?
He knows he is trying to dissuade us and connive with the govt's populist measures for the coming elections.
It is written on the wall - congress will lose!
What with scams, rapes, murders, political vendetta, 'democracy and country be damned' attitude; leaders(?) with z+ security and people to fend for themselves.
Rajas and Kalmadis with blessings of power that be roam freely and innocents are in jails with cases pending!


Krishna Murthy

Jan 7, 2013

If the budgeted fund were not used properly for the productive purposes then inflation, scam, corruption, black money, theft, looting's are expected. Gold import may be good idea to contain such things. It looks that the Doctorate economists integrity is in doubtful.



Jan 7, 2013

Previos years Govt. had curbed Gold Import. Had it given cheap Gold? I think No.


S. Sridharan

Jan 7, 2013

Pl. note that Gold has become crazy for most of the people in India. My opinion is that people should buy
Gold only to a limited quantity that too for their
family marriages and other few special occasions.
I read in an old book that Gold is a HUMAN KILLER
and should not be kept in abudance. People should realise this and act according to it. In India, middle
class people suffer very much for their children's marriages, because of the price impact. People should
boycot surplus gold buying and selling so that every person will have their genuine share in it.


S. Sridharan
Madipakkam, Chennai-600091.


Borkar M.R.

Jan 7, 2013

Sir, In his previous AVATAR as F.M., he was pushing the idea of "consolidating and Making few BIG BANKS. OH GOD YOU saved us. It is still fresh in our minds this "TOO BIG TO FAIL SYNDROME" what devastating effects it has created. And in INDIA where the "SECONDARY ECONOMY (Black Money) is so strong, will we survive? Let there be some Madhavpura like. At least that can be rectified. But if something like LEHMAN Brothers and others happen. What will happen to us? I think GOD IS KIND on Indians. - Let RBI follow its path. - Borkar

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