Govt’s gold schemes will not lower demand for the yellow metal

The world is uncertain so gold is held to take care of a rainy day.

Written by Arun Kumar | New Delhi | Published:January 7, 2016 11:00 am

The four gold schemes launched by the Government of India in November have not served their purpose. Is it due to inherent flaws in the schemes or is it the start of these schemes and they may pick up later?
India is variously estimated to hold between 20,000 and 80,000 tons of gold currently valued at between $830 billion and $3.3 trillion. Gold is a store of value and a small amount of it has a high value so it is convenient to hold. India has a large black economy and some of the savings out of it are held in liquid form as cash and gold.

Gold is also held for precautionary reasons. The world is uncertain so gold is held to take care of a rainy day. The price of gold rises during times of crisis whereas cash loses its real purchasing power. Holding jewelry has the further advantage of being decorative or a status symbol or as a family heirloom. Thus, there are social and economic reasons for holding gold in pure form or as jewelry.

However, it is not like many other assets which yield an income based on economic use. If it is lying in a locker or a cupboard, it is not earning a return except when its price rises. Thus, gold is mostly characterized as a dead investment. It hardly leads to an increase in production in the economy.

India produces little of gold but consumes the most in the world. This demand is met by imports and recycling gold. Imports have been about 900 tons per annum since the late 1990s. While a part of that is legally imported the rest is smuggled into the country.

Imports imply that the nation’s savings are leaking abroad rather than being invested in the country. To pay for it, foreign exchange is either short-circuited abroad to finance the smuggling of gold or it is paid for from the foreign exchange reserves. Either way that aggravates the nation’s Balance of Payment difficulties. Thus, gold results in several problems.

Imports amount to 4 gms per family. If it is assumed that the top 3% in the income ladder buy most of the gold, that would be 120 gms. These rich people hold a variety of assets and gold is one of them. They need to be convinced to hold other assets than gold.

To change people’s preferences, the government has announced 4 schemes. First, the Gold Monetization Scheme under which gold may be deposited in a bank and interest earned on it in gold. So, one’s gold is safe and instead of being a dead investment there is a return. In the second scheme, one can buy Sovereign Gold Bonds which will be indexed to gold prices and earn 2.75% interest. It is like buying gold but with a return and not a dead investment because, the government gets the funds for development. The last two schemes are the issue of Gold Coins and Gold Bullion.

These schemes have macro and micro implications. There will be difficulties of testing purity and possibility of fraud given the leakiness of our banks. At the macro level, the first scheme will collect gold for the government. But jewelry and gold bought with black incomes is unlikely to come out. What would the government do with what comes out? It is not clear jewelers would buy from the government and reduce their demand for imported gold given the sharp practices in this business. The second scheme would add one more asset in one’s portfolio. So, it may not affect demand for gold. The last two schemes are like issuing high denomination currency of value Rs.13,000/-, Rs.26,000/- and Rs.52,000/- approximately. This will increase demand for gold from the black economy because of convenience.

The schemes taken together may not check the demand for gold. Even if the temple gold comes out it would not reduce the demand for gold because temples do not demand gold they get donations from devotees. There is hope for divine intervention from temples like Tirupati which may subscribe to the Gold Monetization scheme. Gold purchased from illegal incomes would not be declared and that is a large chunk of the gold held. So, reduction in illegal activities would determine the success of the gold schemes.

In brief, so long as uncertainty persists, other assets are not attractive enough and the black economy grows, the schemes announced will not lower the demand for gold.


Author of `Indian Economy Since Independence: Persisting Colonial Disruption’

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