How Indian obsession with gold has a negative effect on economy

Accumulated hoarding of gold increases current account deficit. Gold Monetization Scheme (GMS) was announced in the union budget of 2015-16, whereby individuals could deposit gold with banks and earn interest of about 2.5%. However, by 2018 the scheme had attracted only 11 tonnes of gold. Clearly, the scheme has to be recalibrated to make it more efficient – which will help in cutting down gold imports, meeting the gold demand of industrial sector

Mumbai: The gargantuan stock of about 24,245 tonnes of gold in India is accumulated hoardings and not accumulated savings, says an IIM (A) study.

For millennia, gold is considered auspicious in India and consumers have a fascination for possessing gold, gold jewellery, and gold coins.

Along with increasing the propensity of flow of savings going into financial markets and not in physical gold, suggestions are made to popularize and improve implementation of gold monetization scheme (GMS). This will re-channel idle stock of gold into financial markets and reduce deficit on the external account, says a working paper titled as 'Gold is Old: Noble Metal in Indian Economy through Ages'.

"In this paper I document the sacredness associated with gold, the ancient Indian references to gold jewellery, availability and technology of extracting gold in those times, minting of gold coins and its function as a medium of exchange and store of value, and accumulation of gold stock due to favorable trade with the Occident in the common era. I draw attention to Indian obsession with gold in modern times, when none is produced domestically and it contributing negatively to India's external account," says Dr Satish Y Deodhar, Professor, Economics Area at IIM (A) the author of the study.

Just a fortnight prior to the Diwali celebrations the Royal Mint of United Kingdom (UK) released a 20-gram gold bar for sale, intricately engraved with the image of Lakshmi - the goddess of wealth, prosperity and beauty. The gold bar retailing at £1,080 was described by the Royal Mint as a reflection of diverse cultural celebrations in the country. Of course, Indians all over the world in general and India in particular are fond of buying gold on auspicious occasions such as Diwali, Akshay Trutiya, Ugadi, Gudi Padwa, weddings, and quite a few other auspicious days round the year. As reported by the World Gold Council the total household stock of gold in India is about 23,500 tonnes and about 4000 tonnes of it is held by temples. Moreover, about 745 tonnes are held in country's official reserves. Compared to this, the largest official forex reserves in world are with the USA which holds about 8134 tonnes of gold.

Used mostly for jewellery purposes, India's 22 karat gold stock is one of the purest in the world. With the current price of 22 carat gold hovering at about Rs 4600/ per gm, the value of the total stock of gold in India amounts to a whopping sum of about Rs 112 trillion or about $1.49 trillion. Importantly, despite huge demand for gold, India does not produce any gold and all has to be imported. In the 2020-21 union budget the basic customs duty on gold imports was reduced to 7.5 per cent and the import value had surged to about Rs 2.54 trillion since then. Accounting for about 9 per cent of India's total imports today, India has been the largest importer of gold after China. The huge demand for gold by India which has an annual per capita GDP of just about $2000 seems intriguing.

India's gargantuan stock of gold is accumulated hoardings rather than accumulated savings and economic policy needs to re-channel India's gold stock into financial markets, the study says.

The multi-millennia association of gold with sacredness, continued obsession of Indians with gold jewellery, and their perception of gold as a permanent store of value has come at a cost. For an emerging economy like India, despite having an accumulated stock of gold of about 24,245 tonnes valued at a whopping sum of about Rs 112 trillion or $1.49 trillion, gold imports continue to be more than Rs 2.5 trillion a year. Gold imports being about 9 per cent of India's total value of imports, it is an important item contributing to the deficit on the external account. Augmenting supply of gold to counter imports is not an option as of now, at least in the foreseeable future. If Kolar gold mines in Karnataka had stopped producing gold many decades ago, yearly gold production at the Hutti Gold Mines, also in Karnataka is barely more than 1.5 tonnes. The 12th 5-year plan working group had outlined that with new investments, production could be augmented to about 70 tonnes by 2030. This is pittance compared to India's annual import of about 900 tonnes of gold.

Moreover, hitherto absent gold demand from the industrial sector is also likely to go up substantively. A mobile phone contains 0.034 gram of gold. As an efficient and corrosion-free conductor of tiny current, gold is used in all kinds of electronic goods, appliances, and components. It will be required in sustainable generation of power through photocell panels. In fact, gold has become an extremely dependable material in all space applications including making of satellites, rockets, and rovers. So are its uses in medical field, be it dentistry, Ayurveda, or medical equipment. Currently, the worldwide use of gold for technology purposes accounts for 8 per cent of the yearly global demand. In comparison, India's annual demand for industrial use is barely 1.4 per cent. With the government's focus on Aatmanirbhar Bharat, aiming to take contribution of technology and manufacturing to 25 per cent of GDP, there is huge potential for growth in gold demand from industrial sector.

Given this context, most of the gargantuan stock of India's idle gold cannot be viewed as accumulated savings but hoardings. Possessing gold gets considered as an auspicious act and Indians seem to view gold as a 'permanent abode of purchasing power'.

Therefore, government will have to adopt an effective economic policy that recycles the stock of idle gold and channel it for productive purposes through financial markets. Re-channelling idle gold will also reduce annual gold imports significantly and save precious foreign exchange for the country. Importantly, the policies will have to convert not only the stock of hoardings into financial savings and investment but also increase the propensity of the flow of annual savings going into financial markets and not in physical gold. To give an example, for the year 2018-19 India's gross domestics savings rate was 30.1 per cent of GDP. Out of this 18.2 per cent was the annual household savings rate. However, the annual household financial savings rate was only 7.2 per cent. Moreover, a study conducted by NCAER has indicated that nearly 11 per cent of Indian households' savings are in gold. Clearly, there is scope for increasing India's gross savings rate in general and household financial savings rate in particular, it says.

The most critical part of the government policy would be to re-channel the existing stock of gold which remains idle in the private hands. Of course, householders, both men and women would keep a certain amount of gold jewellery with them for regular use and for festive purposes. However, most with additional idle stocks can make their gold/jewellery available to jewellers and industry through market. To this effect, Gold Monetization Scheme (GMS) was announced in the union budget of 2015-16, whereby individuals could deposit gold with banks and earn interest of about 2.5 per cent. However, by 2018 the scheme had attracted only 11 tonnes of gold. Clearly, the scheme has to be recalibrated to make it more efficient.

By 2018 only about 10 banks were participating in the scheme and that too only a few branches would act as collection centres for GMS deposits. Both, the number of banks and their branch network for deposit collection needs to be substantially widened to access the household gold stocks.

Contrary to perceptions, disproportionately large gold holdings in smaller quantities are with the lower-wealth strata of the society. Rural India accounts for 60 per cent of the gold jewellery demand. Therefore, bank branches in rural areas need to participate in GMS scheme with deposits as small as 1 gram. Just as government allowed Jan Dhan bank accounts to be opened even with zero bank balance, similar initiative could be taken for penetration of GMS. Moreover, banks could be incentivised for their effective participation by allowing their gold deposits to be counted in their mandatory cash reserve requirement (CRR).

Furthermore, it would help to give behavioural nudges to customers to open GMS accounts. For example, in the case of LPG subsidy, initially government had appealed to the conscience of the people through print and electronic media to give up the subsidy. Many gave up their subsidy voluntarily before eventually the subsidy got removed. Government and banks could give similar nudges to the individual customers, religious trusts, and temples through print and electronic media to deposit their idle gold/jewellery in GMS. The nudging could happen by providing information that the gold deposits are not only secure with banks but they earn interest of about 2.5 per cent; that there is no wealth tax, capital gains tax, and income tax on valuation, appreciation and interest, respectively, and that customers have the flexibility either to take cash or gold at the end of the deposit tenure. In fact, customers also save the fee they would have paid otherwise when they keep their gold in banks' lockers. Only when the GMS network infrastructure is widened sufficiently and banks generate substantive gold deposits, the complementary Gold (Metal) Loan (GML) scheme can be concurrently promoted widely. Under GML, banks will be able to use the gold deposits of the customers to provide gold inventory needs of jewellers at competitive interest rates. Similarly, the Indian Gold Coin (IGC) scheme which was introduced along with the GMS in 2015-16 can also be effectively used by banks. With the GMS gold deposits at their disposal, banks should be allowed to meet the demand of the fresh customers looking for purchasing minted gold coins through IGC.

The process of hallmarking of gold has been standardized by Bureau of Indian Standards (BIS) by now and this can effectively complement both the GMS and GML. Recycling of gold though these mechanisms have a potential to reduce imports substantially. Temptation, however, to increase basic customs duty from the existing level of 7.5 per cent should be resisted. Decades of experience suggests that higher customs duty leads to circumvention of rules, smuggling, and black marketing; usually with active participation of anti-social elements of the society.

Once household idle gold holdings are channelled through the banks, other gold based financial instruments too will be useful to recycle those gold stocks for new gold customers. For example, gold-backed exchange traded fund (ETF) is listed on National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). It is fully backed by gold of 99.5 per cent purity. This market will develop well when recycled gold deposits through GMS are available for onward loan or sale by banks. Development of such market will help household savings going into financial investments rather than going in physical gold hoardings. Sovereign Gold Bond (SGB) scheme was yet another instrument issued in 2015-16. However, it has not been backed by gold. As pointed out by Reddy, efficacy of this instrument and its benefits are not that obvious both to government and the buyers. Niti Aayog Committee had also proposed a Gold Saving Account (GSA) in addition to GMS. GSA would allow customers to save up in rupees but the accumulated amounts are translated into physical gold. This instrument is meant mostly for lower income new customers to buy gold. Further, Niti Aayog had also proposed setting up a Bullion Exchange that would provide a transparent ecosystem for trading gold, which will aid functioning of other gold schemes.

(This piece is based on the working paper, 'Gold is Old: Noble Metal in Indian Economy through Ages')

Dr Satish Y Deodhar, Professor, Economics Area at IIM (A)