Turkey holds golden delights for India

Gold, as far as Indian policymakers are concerned, is a four-letter word. Investment in gold is unproductive, and imports of gold add a considerable burden to the current account deficit (CAD). However, India's relationship with gold is deeply rooted in its religion and culture and has been so since time immemorial. Gold plays an important role in weddings and other functions and is perceived as an important hedge against inflation. Various estimates conclude that India possesses over 20,000 tonnes of gold, which are held mostly as ‘under-the-pillow’ stock.

Most studies indicate that in view of the populations’ affinity for gold, the demand is significantly inelastic. In fact, it has been observed that the smuggling of gold increases substantially when the price differential between domestic and international prices crosses a threshold limit.

The Cenre introduced the Gold Deposit Scheme in 1999 to mobilise the ‘under-the-pillow’ gold available in the country and put it to productive use, and reduce the CAD. However, the scheme failed to attain even the conservative target of 100 tonnes. The mounting impact of gold imports on the CAD pushed the government to reintroduce this scheme with some modifications in 2009; in 2013 the Reserve Bank of India also eased a number of conditions. However, the evidence does not indicate that the scheme as it exists will succeed in its objectives.

Turkey’s relationship with gold is similar to that of India. Gold plays an important role in its religion and culture. The Turkish Central Bank estimated that ‘under-the-pillow’ stock of gold in 1984 was well over 2,000 tonnes. Some reports indicate that in 2013 it was close to 3,500 tonnes, which was around 12 per cent of GDP. However, unlike India, Turkey has a small but growing gold mining industry.

Turkey’s policymakers realised the important contribution gold makes to the economy. In 2013, jewellery exports, most of which was gold, was $3.3 billion. PriceWaterhouseCoopers estimated that bar, coin and jewellery consumption and fabrication in terms of gross value addition contributed nearly $3 billion to the Turkish economy. In addition, gold recycling would have added $1 billion. The gold industry is estimated to employ around 2,50,000 people. Given the valuable contribution of gold to the economy, circumstances forced the policymakers to innovate in order to reduce the adverse impact of gold imports on the CAD and attempt to bring into circulation some of the ‘under-the-pillow’ gold stock.

During the global financial crisis of 2011, Turkey was faced with a large CAD. There was a serious danger of capital flight and currency depreciation leading to insolvency. In order to tackle this crisis, Turkey’s policymakers designed an innovative policy called the reserve option mechanism (ROM), which allows commercial banks to maintain part of their statutory reserves requirement in gold or foreign currency.

Theoretically, it is possible to demonstrate that this policy instrument will (i) reduce volatility in exchange rate, (ii) reduce the impact of foreign currency inflows on the financial sector, and (iii) reduce the cost of domestic currency liquidity requirement of the banks as they can now meet their reserve requirements at a lower cost. Consequently, this would also bring into circulation ‘under-the-pillow’ gold and have a positive impact on the current account by reducing imports.

However, in order to ensure that the ROM achieves the desired objectives, Turkey’s policymakers realised that all the stake-holders involved in the process would have to be incentivised and the required infrastructure put in place. The stakeholders identified were the consumers, the commercial banks, the central bank, and the government.

Studies have shown that the individual is prepared to participate in a gold deposit scheme provided the interest earned is at least 2-3 per cent, the period of deposit (compulsory) is about 3-4 years, and the minimum quantity is not very large. In addition, an extremely important requirement is purity verification by an internationally accredited laboratory to be done in the individual’s presence. Naturally, ease of paperwork, easy withdrawal, nomination facilities, tax benefits and the like are some other pre-conditions.

Banks will participate in the scheme depending on the relative cost of holding gold to that of domestic currency holding. The relative cost of holding gold would include the interest to be paid as well as the transaction cost (which would include the cost of storage). Accordingly, these factors would have to be kept in mind while designing the ROM. The central bank would be interested in reducing the volatility in the financial sector and the increased stability of the exchange rate. The government’s interest would be served by way of a reduced CAD and by putting gold to productive use.

The success of the ROM was underpinned by the development of necessary infrastructure, which is a precondition for the success of any gold monetisation scheme. Turkey allowed banks to buy and sell gold coins and encouraged banks to introduce a variety of gold-structured products such as gold current accounts, gold accumulation plans, gold lending products and the like. Consequently, banks encouraged refiners and jewellers to set up a network of bank-authorised centres to collect recycled gold after verifying its purity. This necessitated developing world-class facilities for determination of purity in a short time-span to the satisfaction of the customer. This also resulted in improving the quality of gold used in Turkish jewellery, thereby improving quality and workmanship.

Gold makes a significant contribution to the Indian economy. The Indian gold industry employs 2.5 million people and contributes $30 billion to the domestic economy. In 2013, the value of exports of gold items was more than $18 billion. Bringing ‘under-the-pillow’ gold into circulation would bolster the domestic economy significantly. The ROM is one such instrument for this; it will also enable putting in place the required infrastructure such as world class refineries, assaying centres and safe storage which could be utilised for other gold monetisation schemes.

The finance minister has recognised the role that world-class precious metal refining can play in making the ‘Make in India’ initiative successful. The recent Budget introduced some incentives for the gold industry which includes developing a sovereign gold bond, a gold monetisation scheme to allow depositors to earn interest, and Indian-made gold coins to reduce the demand for foreign gold coins. It is time Indian policymakers considered gold as an engine of growth.

The writer was a Secretary in the Government of India

COMMENT NOW