India’s lust for gold
Love of gold becomes a macroeconomic problem
Jan 12th 2013
THE wardrobe of Datta Phuge, a businessman in Pune, in west India, has a new addition. Weighing 3.25 kilos and costing a quarter of a million dollars, it is a chain-mail shirt made of gold. “I always move around with bodyguards,” a glittering Mr Phuge reassured the Pune Mirror. Sadly, India’s gold obsession is no laughing matter. India is the world’s largest consumer. Surging gold imports have helped widen the current-account deficit, which was an alarming 5.4% of GDP in the quarter to September (see chart). On January 2nd the finance minister appealed to the nation to buy less gold.
Some argue that India’s gold imports should be reclassified as a capital flow, which would make the current-account deficit look less scary. But the official fear of gold is rational. Whatever the accounting treatment, money flowing out of India to buy bullion strains its balance of payments. And wealth stored in ingots or jewellery rather than bank deposits or shares is unavailable for investment. India’s household savings rate is high, but as much as half is now squirrelled away in physical form.
Pune’s wide boys aside, the traditional gold consumers are southern peasants buying jewellery. They have no access to formal finance; gold requires no paperwork, incurs no tax and is liquid. But over the past decade the mania has spread. By weight consumption has doubled, for several reasons: a surge in money earned on the black market; investors chasing the gold price; and the dismal returns savers get from deposit accounts. Real interest rates are low, reflecting high inflation and a repressed financial system that is geared to helping the state finance itself.
India has tried coercion. Between 1947 and 1966 it banned gold imports. After that it used a licensing system. Neither worked. Smuggling soared and policymakers were reduced to tinkering with airport-baggage allowances. By 1997 trade was liberalised.
If bullying doesn’t work, what can be done? One option is “dematerialisation”—creating gold-linked products that are not fully backed by imported bullion. The risk is that the firms selling them are then exposed to a swing in the gold price or, if they try to hedge this risk, to derivative contracts with counterparties.
A better alternative is to try to “monetise” gold by encouraging more people to use it as collateral against which they can borrow. Such loans have been booming but are still probably worth just 1.5% of GDP. By contrast, the stock of gold held by Indians may be as much as 50%.
The best bet of all would be a freer financial system that reaches more people and offers higher returns. Just don’t bet on its arriving soon. Mr Phuge, for one, is awaiting delivery of his next investment—a gold mobile phone.