Will India lose interest in Gold?

Background

Gold is one of the most trusted assets in the minds of consumers when it comes to wealth accumulation. It is perceived as money, as an investment, and as an efficient store and source of value. It is an asset that has attracted people for thousands of years because it is highly malleable, non-destructive, easily transportable, universally acceptable and one of the most beautiful of metals. These unique characteristics have made it a coveted object amongst humans and have led to trading in gold for over 6,000 years.

Gold Market

Gold has been uniquely important to Indians fora variety of religious, social, cultural, ritualistic and behavioural reasons. It is viewed as a liquid asset and hence widely recognised for intergenerational succession of wealth as it is considered to be the most efficient store of value.

Across the world, gold is traded in seven markets are –

• London OTC market
• COMEX (New York)
• Three Shanghai Exchanges – Shanghai Gold Exchange (SGE), China Gold Association (CGA) & Shanghai Future Exchange (SFE)
• TOCOM (Tokyo)
• MCX (India)
• Dubai and Istanbul Gold Exchange (ISE).

The London OTC market and COMEX (New York) are the biggest gold markets in terms of quantum activity. China is currently the largest producer and consumer of gold in the world. India, meanwhile, ranks second in terms of gold consumption, and is followed by Japan. Factually, India consumes nearly 800 tonnes of gold, accounting for 20% of world gold consumption. Of this, nearly 600 tonnes of gold goes into making jewellery, as per a 2014 World Gold Council (WGC) report.

Since India’s domestic production is limited, the rising demand has to be met through imports.In the last few years, gold imports in India have risen significantly. India accounts for more than a quarter of global gold imports, despite contributing less than 2%to the global trade. Gold import has been identified as a major contributor to the widening Current Account Deficit (CAD), and therefore the Government of India (GOI) is trying to regulate gold imports.

Economic Trends

According to estimates prepared by the WGC (2010), India accounts for 10% of total gold stocks in the world,with rural India accounting for nearly 65% of those stocks.

As per the WGC report (2014), combined demand volumes in India and China have grown by 71% over the last 10 years. The two markets accounted for 54% of consumer gold demand in 2014 up from 33% in 2005[1].

Note: Chart shows consumer demand in tonnes, which comprises jewellery and total bar and coin demand.

Source: GFMS, Thomson Reuters, World Gold Council

Data compiled by the WGC shows that in 2015 China was the world’s largest consumer of gold, accounting for about 29% of the global demand. India was next, with about a quarter of the global demand. Together, these two countries constituted more than half the global demand for gold.In light of India’s increasing appetite for gold, the government has attempted to regulate consumer demand through interventions like restrictions. Despite these restrictions, jewellery demand in India hit a record 662.1t in 2014.

Economics of Gold

Particulars	2008-09	2009-10	2010-11	2011-12	2012-13
GDP Growth[1]	6.72%	8.59%	8.91%	6.69%	4.47%
Fiscal Deficit[2]	5.99%	6.46%	4.79%	5.75%	4.82%
CAD	-1.27%	-2.80%	-2.81%	-4.29%	-4.82%

Source: Trading economics

Story behind the numbers

• Until 1991, gold imports were banned as per Government of India (GOI) regulations. Since then gold imports have been rising, but it was not a matter of concern
• In 2008, the global recession took a toll on the Indian economy, and growth significantly slowed to 6.8% in 2008-09. It subsequently recovered to 8.6% in 2009-10, while the fiscal deficit rose from 5.9% to 6.5% during the same period
• India’s CAD surged to 4.29% of GDP during FY13 against 2.82% in FY11 due to the increase in gold and oil imports.

A high CAD meant a threat to India’s sovereign rating and hence a possible situation of capital flight out of the Indian economy. In 2012, India entered a period of more anaemic growth, with growth slowing down to 4.4%. Other economic problems also became apparent: a plunging Indian rupee, a persistent high CAD and slow industrial development.

Hit by the U.S. Federal Reserve’s decision to quantitative easing, foreign investors had been rapidly pulling out money from India, which led to unprecedented depreciation of Indian currency which was close to 70 per dollar in 2013. A depreciated rupee put enormous pressure on the CAD and the government had to take measures to solve the CAD problem immediately.

Since gold was a key contributor to the import bill and the highest value luxury-item imported, a clampdown on gold imports seemed the best way out to bring down the import bill. Consequently, the GOI raised the import duty on gold to an all-time high of 10% in August 2013, and later went on to ban imports of gold coins and bars, which made up to 36% of Indian demand. Thus, India’s CAD declined sharply in the quarter ending September 2013 as the effects of the government’s measures to curb imports of non-essential items, especially gold, started to show results.

Role of Government

According to RBI, the demand for gold in India cannot be compared with other parts of the world. With a 1.3 billion population and cultural significance, the demand for gold will be ever increasing from both, investors and gold jewellery consumers. The convenience of cash based transactions and absence of documentation (no paper trail, no obligations, etc.)  pre-2016 made it a preferred channel for money laundering. Hence, RBI believed that any attempt to curb gold demand in India would be a difficult and complex task.

Efforts to curb demands came through this year (2016),in the form of introducing an additional 1% excise duty (which prompted the jewellers’ strike in Q1 FY16). Additionally, the requirement that purchases above Rs. 2 lakhs need a Permanent Account Number (PAN) card have acted as headwinds to the industry, impacting demand in the organised sector most notably[3].

It is also worth noting that RBI sees gold demand as inelastic. In the long-run, gold savings are attractive as it provides insurance against instability, protection against market risk and high liquidity and has no substitutes with a similar risk-return profile. Thus, gold demand is relatively unresponsive to rising prices, and import bans would simply cause consumers to take recourse to unauthorised channels to buy gold. This is perhaps why India will not lose interest in gold in the long-run irrespective of the current ups and downs.

Impact of Demonetisation

The recent demonetisation move of the government has led to a lot of uncertainty in the economy in general and the gold market in particular in the country. The rush to dispose old currency notes and the safe haven characteristic of gold led to a sharp surge in gold demand after the announcement.[4]

However, the rush for buying gold has slowed down due to a combination of factors like government crackdown on use of gold for black money conversion, fear of prolonged shortage of notes, and global factors like the US Fed hike and steady rise in oil prices.

Over a longer period of time like 6-12 months, the government’s demonetsation move is unlikely to either boost or hurt demand for gold. Demand for gold may rise after shortage of notes ease out as buyers who chose to defer gold purchases start buying again.

The transition to digital payments and reduction in black money may boost the economy, which may temper demand for gold as an investment asset. Investors may prefer to allocate funds to equity to take advantage of the booming economy.

Yet, global factors like the USA raising interest rates and rising oil prices may lead to investors staying put in gold as a hedge against uncertainly. So, barring the short-term variation in demand and prices, there is unlikely to be a very significant impact on demand for gold in India.

Conclusion

Based on the above correlations, in India, rising gold prices have not adversely impacted the demand for gold. While higher income groups can diversify their investment portfolio in accordance with the risk-return trade off, the weaker sections of the society depend more on gold to hedge against inflation. The jewellery bought from savings is generally used during emergencies. The segment of population facing borrowing constraints have incentives to purchase more gold jewellery during their prosperity (hence rising gold imports) to use as collateral during distress.

There is need for a gold policy independent of CAD, to be in place. The regulator landscape has been quite reactive in nature of the CAD problem. The sudden change from a relaxed intake, however, is unhealthy for the industry owing to the fact that imports are getting routed illegally and the industry still suffers from lack of transparency. There is an imperative need for a medium-term (next 2-3 years) roadmap of regulations post deliberation and consultation from all stakeholders in the value chain.

A necessary pre-condition for reducing excessive gold is to ensure low inflationary environment and macroeconomic stability. Absence of any close substitute to gold as an investment asset and high liquidity that gold can offer are two major reasons why gold will be a preferred asset for the Indian consumer in the coming times.

References:

• World Gold Council (2014), “China’s Gold Market: Progress and Prospects”, China Report, April.
• World Gold Council (2016), “Global Demand Trends: Second Quarter 2016”, August.

International Journal for Innovative Research in Multidisciplinary Field Article, An analysis of fiscal deficit in India (1991-92 to 2015-16) by Nandini Sud.