Gold meets the ordinary Indians’ need for a long-term store of value, better than bank deposits or mutual funds.
The growing crisis in the current account deficit has understandably generated considerable attention in official circles to the need to curb gold imports. There have been a series of measures designed to influence the demand for gold, including raising import duties on the metal. But these measures suggest a tendency to see gold as just another metal, albeit a precious one.
There is little attention paid to the unique combination of roles that the metal plays in an Indian household. And without adequate attention being paid to the multiple dimensions of the metal, the set of measures can prove to be ineffectual, if not counterproductive.
A major reason for the Indian attraction to gold is the widespread recognition of the metal as a means of transferring value across generations. Major milestones in life, especially marriages, are typically marked by a transfer of gold. This faith in the abiding value of gold over long periods of time makes it a constant in times of rapid change. This faith ensures that in times of economic uncertainty, like the present, households tend to fall back on gold.
Gold is also an effective demonstrator of status of the Indian household. In many cases it competes with land ownership as the means of demonstrating wealth. There are specific situations, especially in rural areas, where the ownership of land can be a much more effective indicator of power and status.
But gold has an advantage over land in that it is much more divisible. It can be used as an indicator of economic status even by those who cannot afford to own the land they live on. Gold is thus an effective demonstrator of status for a wider range of Indians than land.
The long-term value of gold should normally be offset to some extent at least by the lack of liquidity. It has been centuries since gold could be used for market transactions. The need to convert the long-term value into the means for transactions was traditionally met by the local moneylender.
Organised banking tended to frown on this practice. But the recent spurt of interest in gold has seen banks learning a trick or two from money lenders. Nationalised banks are competing with each other to offer the best gold loans. The scene of individuals seeking loans on the basis of family gold jewels is now not confined to the pawnbroker’s shop.
Once we take these additional dimensions into account, it is easy to see that instruments that work with other commodities may have a different reaction in the gold market. Elementary economics tells us that an increase in price caused by higher import duties should result in a decrease in demand. In the case of gold, though, other facets of the metal could generate the opposite reaction.
The higher prices further strengthen the faith that the metal will only provide higher returns. The higher prices also increase the amount that can be borrowed against a given amount of gold. And the higher the price of the metal, the greater the status associated with the display of gold ornaments.
An effective strategy to control gold imports must then move beyond measures that raise the price of the metal. Gold bonds have been used as a means of distinguishing between the demand for the monetary benefits the metal provides and the need to actually hold gold.
The bonds do meet the demands of those seeking the economic security that gold is popularly believed to provide. In the process they convert at least some of the demand for gold into a demand for paper. But they do not challenge the faith in gold.
Thus, while the bonds can meet a part of the short-term objective of reducing the imports of gold, they do little to alter the unique place gold has in the Indian mind.
The longer term alternative to gold would then have to be independent of the price of the metal. It would be too optimistic to expect the alternative to play all the roles that gold does in the Indian psyche.
But if it could offer at least some of the benefits that gold does, it would reduce the demand for the metal. And an instrument that could meet the need the ordinary Indian faces for a lasting store of value could have that effect.
Indeed it could be argued that one of the reasons for the spurt in the demand for gold is the failure of the post-liberalisation economy to come up with a savings instrument that could gain the trust of the people.
With the liberalisation process working actively towards the reduction of interest rates, the long-term value of bank deposits has been eroded. This was supposed to have been offset by the rise of pension funds and mutual funds that would offer such high returns that those in need of a long-term store of value would not mind lower interest rates. But mutual funds have not played this role.
The growing fascination with gold is thus a symptom of a larger inability to meet the essential need of ordinary Indians to have a longer-term store of value. An effective strategy to curb gold imports should address this need rather than be satisfied with tweaking an import duty or two.
(The author is Professor, National Institute of Advanced Studies.)