CIRCUIT BREAKER. Three new ways to halt India’s gold rush

Latest data showing that India’s gold imports have jumped four-fold in September and October, compared to the same months last year, have sent many into a tizzy. Policymakers have gone into a huddle to see what they do to nip this trend in the bud. Dire warnings have been issued that they should swiftly tighten the 80:20 rule, or else the current account deficit will spin out of control, like in 2011.

But it may be best not to heed this advice. Instead of continuing with stop-gap and draconian measures such as the 80:20 rule to curb gold imports, the Government should now look at three long-term solutions to tackle India’s burgeoning appetite for gold.

When bullion prices tumble, as they are now, Indian households usually rush to stock up gold for their daughters’ weddings (yes, this is regressive, but who can argue with tradition). If you can’t beat them, you can join them.

So why not encourage these savers to buy their gold in instalments over many years, instead of purchasing it all at one go?

That’s what Gold Accumulation Plans (GAPs) facilitate. These plans, quite popular in countries such as China and Japan, allow investors to buy gold in monthly instalments much like mutual fund SIPs. So, the saver signs on for a 5-year or 10-year GAP and deposits small sums (say ₹1,000 or ₹5,000) with the bank every month, to acquire gold at prevailing market prices. At the end of the period, he GAP ‘redeems’ his units either in the form of bullion or in hard cash. GAPs may turn out to be a winning proposition for both gold buyers and banks who offer them. The buyers get to average their gold purchase costs, thus benefiting from periods of falling prices.

Banks, on their part, can charge both a hefty upfront commission and an ongoing fee for operating the scheme. Today, gold jewellery buyers cough up wastage, making costs and other expenses that total up to 10-15 per cent of the purchase price, in many cases. They may be quite willing to pay a sizeable 5 per cent fee to participate in a GAP, especially if the purity of the underlying gold is also certified.

The RBI’s KUB Rao committee, which examined this issue in great detail in 2013, found that banks overseas did not hold the entire gold required for these GAPs in physical form. As all investors were not likely to redeem their units at the same time, they would typically hold 20-30 per cent of the funds in cash or liquid securities, while hedging against gold price risks.

Indian GAPs can help curb gold imports in two ways. By nudging savers to phase their gold purchases over many years, instead of buying them in one big splurge, they can make bullion imports more predictable and do away with the tendency to hoard. As they would only hold a part of their assets in physical gold, they can achieve a 20-30 per cent net reduction in bullion imports.

The other imperative for policymakers is to get the gold hoard lying with Indian households back into circulation. One reason why domestic bullion demand seems to be so insatiable is that gold, in the Indian context, is highly illiquid. Most jewellery or coin purchases turn out to be a one-way street, where the asset goes straight into the bank locker seldom to be seen again. The key reason why gold buyers don’t liquidate their holdings, is that they are forced to suffer a significant loss on such swaps.

Only a few jewellers offer to pay cash for any gold that is traded in and if they do, they deduct hefty making charges, wastage and other costs that the buyer incurred on the purchase.

As for banks, while they have actively marketed certified gold coins and bars in the past, they don’t buy back these coins.

To unlock the vast hoards of household gold, banks must be allowed to buy back hallmarked coins or bars, levying a processing fee. Banks, being institutions, shouldn’t find it difficult to liquidate this gold in the international market. A liquid and transparent two-way market for bullion operated by the banks, may also force jewellers to come up with competitive schemes to buy back gold.

Alternatively, as suggested by the Rao Committee, the Government can consider opening a specialised Bullion Bank that hedges price risk and actively transacts in bullion with retail consumers. An estimate by the World Gold Council suggests that the gold squirreled away by Indian households amounted to about 20,000 tonnes at last count. Unlocking even a tenth of this can help take care of two-three years’ import requirements.

While it may be quite acceptable for small savers to use gold as a store of value, there is certainly no rationale for allowing affluent investors to use bullion as a store of ill-gotten wealth. Though all financial instruments and even property transactions now require a PAN number, bullion purchases remain exempted, no matter what their value. This is inexplicable, as purchasing jewellery or gold bars and stashing it in a bank locker is surely the easiest way of holding on to black money.

Though the Government did announce a PAN card requirement for all jewellery purchases in an earlier budget, the new rules were for some strange reason, never enforced. Given that the current Government is quite keen to track down black money, it can start by strictly enforcing a PAN card on all gold purchases above say, Rs 1 lakh. This should curtail the demand for gold as a tax haven and ensure that imports go only to meet genuine consumption demand.

But is there time to hammer out long-term solutions? What if the CAD shoots up to crisis levels in the interim? That’s not likely because gold imports this year are not as alarming as they are made out to be; they are still 30 per cent below those in 2011. While gold imports valued at $4.8 billion for October 2014 may technically represent a four-fold jump over October 2013 ($1.4 billion), this ‘jump’ is exaggerated. Indian bullion imports always spike sharply in the festival months of September/October; the spike is magnified now because there were negligible imports last festival season; the bullion trade was in shock after the regulatory curbs of August 2013.

Going by past experience, gold imports may decline in the coming months as the Diwali effect wears off. It should also be noted that, thanks to tumbling crude oil prices, the recent surge in bullion imports hasn’t caused the trade deficit to spin out of control. For April-October it was 4 per cent below last year’s level.

This is not to say that gold imports should be encouraged or that they don’t pose a risk to India’s external equation in the long run. They certainly do.

But given that Indian gold buyers aren’t going to give up their age-old preferences just out of patriotic fervour, artificial curbs on supply through measures such as the 80:20 rule, only encourage smuggling and hoarding of bullion.

Sometimes, the best way to quell an insatiable craving for something is to have it in abundance.

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