6th International Gold Summit
India: Global Gold Trading Hub
Containing the Demand for Gold
by
Dr. C. Rangarajan
Chairman
Economic Advisory Council to the Prime Minister
May 15, 2013
The Associated Chambers of Commerce and Industry of India
New Delhi
Containing the Demand for Gold
by
Dr. C. Rangarajan
Chairman
Economic Advisory Council to the Prime Minister
It gives me great pleasure to be in your midst this morning. This Summit organised by the ASSOCHAM focusses on a issue of critical importance today.
Gold has been a valuable asset since ancient times in all cultures and across all periods of history. The main reasons for this are that it is universally acceptable as a store of value; it is a way of transferring inter-generational wealth; it serves as a hedge against political and economic uncertainty, including inflation; and it provides liquidity in times of need. Gold was for long minted as currency and paper currency was exchangeable for a fixed quantity of gold in many countries till the middle of last century. The abandonment of the last vestiges of gold standard in 1971 by the US ushered in an era of floating currencies.
Gold has a special place in the Indian psyche. Over the centuries, India has accumulated a huge stock of gold. Although India does not have any functioning gold mines, it is the largest consumer of gold in the world today accounting for nearly one-third of the world demand for gold, and also holds a little over 10 per cent of the entire global stocks of gold above the surface. Recent years have seen a sudden surge in the import of gold and this has become a major cause of concern because of the adverse impact on the current account of India’s balance of payments and on financial savings.
In quantitative terms, India’s import of gold has increased from 471 tonnes in 2000-01 to 1,079 tonnes in 2011-12 and 1017 tonnes in 2012-13. In value terms, it has increased from US $4billion in 2001-02 to US $56 billion in 2011-12, and $54 billionin 2012-13, which translates into a fourteen fold rise roughly over a decade. What is of particular concern is the sharp increase in imports since 2008-09. In value terms, it increased from US $21 billion in 2008-09 to US $29 billion in 2009-10, to US $41 billion in 2010-11, to US $56 billion in 2011-12 and $54 billion in 2012-13. In 2011-12 gold imports accounted for 72 per cent, and in 2012-13 57 per cent of the current account deficit. It is true that some part of the imported gold is utilised in the manufacture of gems and jewellery which are exported. But this is hardly equal to US $7 billion in 2012-13. If, in fact, India’s demand had remained at 700 tonnes instead of the actual 1,000 tonnes in 2011-12, and 2012-13, the current account deficit would be less by about $20 billion and $17 billion respectively. In other words, India’s current account deficit would have been 3.1 per cent of GDP instead of the actual 4.2 per cent of GDP in 2011-12, and 4.2 per cent instead of 5.1 per cent in 2012-13. In addition to quantitative reduction, if the current trend in world gold price is maintained, the impact on the current account deficit will be significant. In order to be able to bring down the demand for gold, we need to look at the basic factors influencing demand.
It is argued sometimes that we must make a distinction between the import of gold and other commodities. Imported gold stays within the country and does not get destroyed like other commodities. It is true that the stock of assets in the country increases but they lie in the hands of private individuals. As far as the impact on demand for foreign exchange is concerned, there is no distinction between the import of gold and other commodities.
Before examining the issue in the context of India, let us look at the world picture. In 2012, as per the World Gold Council, annual global gold demand recorded an all-time high of US $236.4 billion. On a tonnage basis, demand totalled 4,405 tonnes. India and China together accounted for more than 50 per cent of the total demand. Apart from the traditional sources of demand such as jewellery, technology and investment, in the last few years central banks have emerged as an important source of demand. The global economic stress seems to have prompted central banks in several countries to accumulate gold and diversify their foreign exchange reserves. Since mid-2009, central banks have turned net buyers from being net sellers of gold. In 2012, net purchases of central banks accounted for 535 tonnes which was almost 12 per cent of the total demand. At the end of March 2012, total official gold holdings were about 31,000 tonnes.
Since 2002, the price of gold has been steadily increasing. From around $350 per ounce in 2002, it reached the peak of $1,771 per ounce in September 2011. It went down for some months until it went back to $1745 per ounce in September 2012. Thereafter, it has been declining and as of May 14, 2013, the price of gold stands at $1440 per ounce. The recent decline has been very sharp almost by 16 per cent as of now (at one point, it was lower by 25 per cent), although in absolute terms the price remains high by historical standards. Some attribute this decline to expected sales of gold by some central banks of debt stressed European countries. Some others feel that it may be a correction to the previous steep increases. Gold prices are unlikely either to go up or go down in the coming months.
Gold demand has essentially two components:
1)Consumption demand. This type of demand includes demand for jewellery, demand for gold as an input in certain electrical devices, etc.
2)Asset demand for gold as an investment. This may be in the form of gold coins and bars, etc.
Consumption demand which is primarily dominated by the demand for jewellery is influenced by income and taste. Taste and customs do not change dramatically in a short period. Nevertheless, we need to take it into account the extraordinary attraction for gold jewellery in India. It remains high. Demand for gold as an investment depends on the return on gold and the return on financial assets. During a period of high inflation, gold becomes a hedge against inflation as the return on gold far exceeds the return on financial assets. Gold can also act as a hedge against fluctuations in exchange rate. It is interesting to note that the surge in gold import in the last three years coincides with a period of high inflation. Some estimates show that investment demand for gold as a share of total demand increased from 24 per cent in 2009 to 36 per cent in 2012.
Now, a critical question before us is how to contain and reduce the demand for gold and consequently, gold imports. I can think of three kinds of strategies for achieving this.
First and foremost, we must tame inflation. Simultaneously, we need to make the return on financial assets more attractive. This will help in reducing the attraction for gold as an asset. Thus a reduction in inflation combined with attractive return on financial assets could help to contain the demand for gold as an asset. In this context, several gold related financial products have been suggested that could reduce the demand for gold. All of these schemes link the financial product to the value of gold. In these schemes such as gold deposit scheme, the gold deposited is returned after the period of maturity either in the form of metal or in equivalent value. Such schemes may help to mobilise privately held gold stocks into the hands of the financial institutions which could utilise the gold thus mobilised at least in part to provide gold loans to other users. Gold exchange traded funds will enable investors to accumulate gold in small quantities over a period of time. However, investors have to bear the asset management fee as well as brokerage charges. Such instruments do not lower the demand but defer it to a later period. Inflation Indexed Bonds that are being presently contemplated can also turn out to be a strong substitute for gold. In substance, if we have to succeed in containing the demand for gold, we must act on ensuring that the financial products give adequate return. Financial products in this context should cover a wide range from bank deposits to mutual funds products. Keeping inflation down will be a great help. If capital flows are adequate and if the exchange rate remains reasonably stable, that will also help.
Secondly, some fiscal and administrative actions such as the increase of the import duty can be, and recently have been, taken to dampen the demand for gold. Equally, RBI has taken certain steps to stem the import of gold.
Thirdly, the demand for gold imports could be reduced by improving the institutional mechanisms for domestic trading in gold, as there is an asymmetry in the ease with which gold can be bought and sold within the country. Gold can be bought easily from banks and jewellers. However, while gold can be easily bought, it cannot be easily sold, as sellers are completely dependent on informal markets for selling gold. Such trades are non-transparent at best and extortive at worst. The absence of a symmetric two-way quote deprives investors from getting the appropriate price of gold and, thereby making the incremental demand for gold overly dependent on imports. A recent suggestion to set up a Bullion Corporation which could harness idle domestic gold should be viewed in this context. While such a corporation can have a wide mandate, the primary objective should be to mobilise the domestically available gold into the hands of the financial institution. The success of such an institution would therefore depend on the trust that the holders of gold or gold jewellery are willing to place in such an institution.
To conclude, India has always been a big consumer of gold, and this is unlikely to change. The recent surge in gold demand is however creating some distortions and needs to be rolled back to boost growth by reversing the trend of declining financial savings, and by keeping the current account deficit within prudent limits by containing the demand for gold imports. Within the wide spectrum of activities that are required to reduce the current account deficit, critical attention needs to be paid to the import of gold. The spurt in gold imports in April 2013 has raised a serious concern. The sharp increase in April imports could partly be due to the sudden fall in the price of gold and people wanting to take advantage of it. But, as gold prices remain stable, the demand may come down. The imperative to contain the import of gold has become urgent. As a first step, we need to bring down the demand for gold from the current level of 1,000 tonnes per year to a level of 700 tonnes which prevailed only a few years ago. Demand for gold depends on multiple factors such as income, taste and custom, return on gold, inflation and return on financial products. While efforts must be made to reduce the basic attraction of gold to the people in India, at least, in the short run, we can start acting to reduce the demand for gold as an asset. Taming inflation and enhancing the real rate of return on financial products are fundamental pre-requisites for containing gold demand in India and thus reducing the adverse impact on the current account.
1