How too much gold is a drag on Indian economy

Tina Edwin, Economic Times 25/3/2012


The India-gold love affair is now facing a close scrutiny from the government. The budget has doubled import duty on bullion and non-standard gold to 4% and 10%, respectively, and slapped a 1% cess on unbranded jewellery. FM’s message is clear: reduce gold’s allure and head off Indians to other investments. For, too much gold is a drag on India’s economy. Here’s how:

The BIG Hoard – 20,000 tonnes

According to the World Gold Council, that’s approximately how much gold you’d find if you put together the store of individuals, institutions and the RBI at the end of 2011. Of this, 933.4 tonnes were added last year. Valued at Rs 27,000 per 10 grams, this stockpile is worth roughly Rs 54 lakh crore, 60% of the nominal GDP of India in 2011-12. Only a fraction, about 557.8 tonnes, is held by the RBI and constitutes 10.5% of India’s forex reserves.

But We Don’t Use Most Of It

2:1 is the ratio of gold to gross domestic capital formation. Had Indians bought more goods and services instead of gold, capital formation (economists’ term for fresh investments) would have been higher than Rs 26.92 lakh crore for 2010-11. How? Higher demand would push companies to expand capacity or invest in greenfield projects to build some items they currently import.

And Gold Doesn’t Work On Its Own

6.8:1 is the approximate ratio of the value of gold holdings to financial savings of households. Investments in financial instruments such as fixed deposits, insurance and equities release funds for productive activities by both the government and corporate sector. Gold does nothing but idle in safes or bank deposit boxes.

Yet, even though gold prices soared, household purchases did not decline proportionately. Instead, financial savings took a hit, falling to Rs 7.68 lakh crore in 2010-11 from `8.35 lakh crore in 2009-10. Inadequate banking infrastructure is to blame too: most of rural India cannot access financial instruments and has no choice but to buy gold as savings.

Plus, Gold Saps Precious Resources

Gold is the third largest component of India’s import bill beaten only by crude oil and capital goods. Crude keeps the economy running and capital goods help produce other goods, build infrastructure and keep growth rolling. But gold’s contribution to the economy is minuscule. Yet we spent $33.9 billion in 2010-11 to meet 92% of the gold demand. This year, the bill is likely to inflate to $58 billion, according to estimates of the Prime Minister’s Economic Advisory Council (EAC).

Gold Also Further Skews Numbers That Matter

Gold Imports as a % of GDP
1.7 in 2008-09
2.1 in 2009-10
2.0 in 2010-11
3.1 in 2011-12

12% is the estimated proportion of gold in the current year’s import bill of $479 billion. The trade deficit is likely to be $175 billion. If we imported less gold, the trade deficit would be less ugly. As a result, the current account deficit would have looked better and reduced depreciation pressure on the rupee. Import of gold also leads to imprudent use of foreign exchange earnings. A Macquaire Research report says the country’s net gold imports widened the current account deficit by 40 to 130 bps between 2007-08 and 2010-11.

So Will Import Duties End India’s Love Affair With Gold?

Unlikely. The World Gold Council believes there may be a very short-term impact on demand. In the long run, this increase will not matter. This is because the fundamental reasons for buying gold jewellery, rooted in Indian culture and weddings, remain unchanged. The demand for gold as an investment, driven by the need to protect against inflation, ease of liquidity and as a monetised asset to secure loans, will also be unaffected.

Some shining factoids

557.75 tonnes – Is RBI’s gold cache. Of this, 265.49 tonnes are held at Bank of England and Bank for International Settlement.

300% – Is the increase in gold holding of ETFs between 2009 and 2011. Now the stockpile is about 30 tonnes.
0.47 grams – Was India’s per capita consumption of gold jewellery in 2011.


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