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Gold: Why and How does it impact the Indian Economy?

Hi Guys,

Indian Economy has not been in a very good shape recently. All the economic articles in Newspapers and websites have been reporting gloominess. In the recent months, many of us would have come across this statement multiple times – ‘Please Stop buying Gold’. Our Finance Minister and his team didn’t know a quicker way to stop the decreasing the Current Account Deficit. The import duty on Gold went up from 4% at the starting of this year to 10% step by step. 20% of the Gold imports needs to be exported back again with some value addition.

So, what has been happening? Why all this measures all of a sudden? I decided to look into the issue and what has been happening over the years.

In 2001, the total world production of Gold was 3764 tonnes and India imported 462 tonnes, which turns out to be 12.27% of the total production. In 2012, the total production was 4130 tonnes. India imported 1079 tonnes which turns to be 26.12%. India has consumed one-fourth of the total gold production.

What could be the main reasons? Traditionally, Indians always have an affinity towards Gold Jewellery. In the recent years, we have started moving from the concept of Gold Consumption (buying for Jewellery) towards Gold Investment (buying for future benefits). In 2011-2012, 56% of Gold Imports happened through Banks. It is said that Gold has been purchased more due to the high returns it offers. But if we compare the returns between the period of April 2003 and March 2013, Rs.1000 investment would have given Rs. 5267 in Gold, Rs. 6158 in Sensex, Rs. 5746 in Nifty (Bank deposit at 8% would have given Rs. 2337). So, comparatively stock market has given more benefits.

Stock markets have remained out of reach for most of our population. Many of our fellow citizens are unaware of the stock market. There are many intricacies in dealing with our stock market and hence it is an unviable option for most of our citizens. Though stock markets have given better returns, Gold wins in terms of the consistency. If we draw a graph between stock and Gold, the growth of Gold will be more linear and stock market would be filled with crests and troughs.

Gold is considered more liquid compared to Real estate. It also doesn’t require huge investment. Typically, it is said Peasants are the largest consumers of Gold. It protects them from Inflation. It is said to the best Hedge from uncertainties. It has been found that for every 1 % increase in income, gold consumption increases by 1.5%. India’s Golden period also happened between 2003 and 2010 when the GDP growth was spectacular and the per capita income increased tremendously. Also the MNREGA scheme increased the income of Rural masses and their primary investment turned out to be Gold.

Why has this become a big issue all of a sudden? To know this, we need to know what Current Account Deficit is. Current Account is the difference between a country’s Total Exports to Total Imports. If we have more exports compared to imports, we have Current Account Surplus. If we import more, we have Current Account Deficit (CAD). If we have CAD, we need to use our Forex reserves to settle and in the process, we deplete the Forex reserves. If it continues, in the long run we might not have money to get imports.

From 2007 to 2012, CAD has increased from 1.3 to 4.2% of GDP. Net Gold imports has increased from 1.1 to 2.7% of GDP. Net Gold to Current Account Balance has hovered around 70%. Gold export as percentage of Gold Import has decreased from 41% in 2008-09 to 29% in 2011-12. Gold has remained as one of the chief contributors to CAD. In brief, if we stop importing gold, our CAD would become 1.2% of GDP.

India imports three things mainly – Crude Oil, Cooking Oil and Gold. The first two are essentials. Gold is considered to be Non-essential. So our Government wants to reduce the import of Gold. There are many shortfalls in this appeal.

We do not have a safe investment medium compared to Gold. As I mentioned above, it is so easy to buy and sell Gold. People do not trust the other alternatives. The increase in import duties and other restrictions, increase the scope of smuggling. It has already increased. The difference between prices in India and Nepal is 750 Nepalese Rupee per gram (which is nearly INR 468). Recently, 35 kg of Gold has been caught when it smuggled from Nepal into India. Pakistan’s gold imports have increased all of a sudden. Sri Lanka has mirrored India in the Imports Duty rate due to fear of Smuggling.

I read another interesting perspective a few days back. If the investment in Gold goes down, the consumption in Economy increases. It leads to higher liquidity in the economy. The inflation goes up. This is mainly due to the lack of investment interest in other alternatives.

In the short run, Government should aim for decreasing other non-essential imports. Here are values (in Rs. Crore) of some of the non-essential imports published in the Economic Times 2 days ago. Apples: 1152, Booze: 1150, Cashew: 5433, Dolls: 431, Mobile Phones: 25835, Spectacles: 366, Cosmetics: 2173, Almonds: 2105 among many others. Government should try and increase the domestic production of these goods. It could create employment, curb imports and boost exports.

Increase in Gold Imports has been a trend over the past few years and stopping it all of a sudden is not possible. Government should try and create alternatives for Gold in the long run. Otherwise, people are not going to stop buying Gold just because the Finance Minister is saying.

Happy Reading!!!

P.S: Though I have referred many articles for writing this post, the main reference is a RBI report on Study ofIssues related to Gold Imports. You will find many informative data and graphs in this report. If you want more insight, read this report. The URL is http://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/RWGS02012013.pdf