Great Divide on Gold: Policy and Consumer Preference
In India there is a great divide between consumer preference for gold and the policymakers' objective of curbing this demand. Since domestic production of gold is insignificant the demand for gold is met essentially by imports and to a limited extent by recycled gold. From time to time the authorities are alarmed by the large balance of payments current account deficit (CAD) and policymakers invariably go in for savage measures to curb gold imports. While the authorities claim credit for the fall in official gold imports, the full demand is met by increased smuggled imports of gold.
The Split Personality Syndrome
Policymakers, politicians, civil servants, bankers, corporate honchos, academics and economists unanimously feel that the Common Person is addicted to gold and that suitable measures should be taken to curb the craving for gold.
What is galling is that the very people who denigrate the Common Person's affinity for gold, are, in their personal capacities, are also addicted to gold. This is the split personality which is all pervasive in Indian society.
Consumers in India have a strong preference for gold simply because the long-term return on gold is much higher than that on any other savings instrument. We would of course be told that between two specified dates the Sensex outpaced the return on gold.
Historical Experience of Curbing Gold Demand
With the inception of World War II, curbs on gold were initiated under the Defence of India Act, 1939. These measures failed to curb the demand for gold. In 1963, the draconian Gold Control Order was legislated (the 14 carat gold system) but within a year this was diluted and later totally abandoned.
In the Union Budget Speech for February 1992 there was a proposal to set up a Gold Bank, essentially to mobilise domestic hoards of gold, but the scheme was scuttled as influential policymakers articulated that this was not a viable proposition.
In the Budget of February 2015 a comprehensive programme for mobilising domestic hoards of gold was unveiled and the details are now being worked out.
Gold Monetisation Scheme
Three schemes have been outlined. First, a Gold Mobilisation Scheme to replace the present Gold Deposit Scheme being implemented by banks. Second, a Sovereign Gold Bond which would be redeemed at the rupee price of gold prevailing on redemption. Third, an Indian Gold Coin.
First, under the Gold Mobilisation Scheme the banks would be able to offer much higher rates than under the present Gold Deposit Scheme. The banks could lend to importers of gold at higher rates and thereby offer higher rates to those depositing gold. There could, of course, be asset-liability maturity mismatches and there could be a refinance back up facility from the RBI.
Second, under the Sovereign Gold Bond Scheme there could be a number of alternative sub-schemes: (i) There could be a scheme where the bond holder subscribes rupees and this is redeemed at the maturity date in rupees but at the prevailing price of gold. (ii) The bond holder subscribes in gold and the bond is redeemed in gold- in such a scheme there could be an issue of bonds with different maturities and a secondary market could provide liquidity. This scheme would be of value to holders who need the gold after a few years. (iii) There could be a Bond subscribed in gold but redeemed in rupees. These alternative schemes would need to have well structured rates of return.
Third there could, from time to time be issues of Gold Coins which would then reduce import of gold coins.
While these schemes are unexceptionable and must be implemented, as Professor Charan Singh effectively brings out (TheTribune, April 15, 2015) there are a number of detailed aspects which must be given early attention. The schemes should be carefully crafted taking into account location of gold holdings, the size of holdings and liquidity requirements. Needless to say the RBI Report of the K.U.B. Rao Working Group should be a reference document for developing these schemes
A ttempts to Abort the Proposed Measures
There would no doubt be powerful advocates who would argue that these schemes should not be introduced and if introduced should be scuttled. Some opponents of the gold mobilization schemes argue that all that needs to be done is to undertake strong measures to curb the craving for gold. It would be most unfortunate if the 1992 cloak and dagger episode is repeated in 2015 to abort a measure proposed in the Budget of February 2015.
For successful mobilisation of a part of large domestic hoards of gold (reportedly 20,000-22,000 tonnes), it is necessary to offer attractive rates of return on such investments. It needs to be recalled that when mutual funds were first introduced in India a princely amount of Rs 6 crore was mobilised in the first year. The mobilisation of domestic gold hoards will require a long term strategy with possible course correction. The capacity to pay an adequate rate of return would be contingent on using the mobilized gold for on-lending to potential importers of gold and not merely locked up in the official coffers. With properly implemented scheme a part of the domestic gold hoards could be recycled. Let us hope that the authorities do not derail an otherwise viable proposal.
Note: This article was first published in The Freepress Journal on May 18, 2015. Syndicated.
This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.
More Views on News
Jun 10, 2017
Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.
Aug 21, 2017
Most Indians who cannot find jobs, look at becoming self-employed.
Aug 21, 2017
PersonalFN explains the chief factor pushing gold prices up of late.
Aug 21, 2017
One of the hallmarks of successful investing is to look out for companies that have a unique and enduring moat.
Aug 19, 2017
Ever heard of Lindy Effect? Find out how you can use it to pick timeless stocks.
More Views on News
Aug 10, 2017
Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.
Aug 8, 2017
'Yes, it looks like a bubble. And, yes, it's like buying a lottery ticket. But there's something happening that has never happened before. It's an evolutionary leap in money itself.'
Aug 8, 2017
Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...
Aug 12, 2017
The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.
Aug 10, 2017
Bitcoin hits an all-time high, is there more upside left?