Even if it proves to be a blip, this week’s volatility in gold may have its uses. For one thing, Tuesday’s steepest single-day price decline in seven years should make bankers wary of storing up future trouble by writing risky sub-prime loans against the country’s most-loved commodity.

Gold has a strong emotive appeal to Indians, who own one-eighth of the metal ever mined. Of late, though, the glitter was beginning to blind the authorities, too. India’s central bank recently raised the loan-to-value limit for advances against gold jewellery to 90 per cent from 75 per cent.

Now that the international price has fallen by 5.7 per cent in one day, and jumped by 1.3 per cent the next, banks will be uneasy with such low margins of safety. Risk aversion will deter them from giving out loans that might not be repaid. However, lenders may still may push borrowers to take up new gold-backed loans to repay delinquent unsecured credit after the central bank’s Covid-19 moratorium on repayment ends this month. If the money doesn’t return, they can at least sit on the commodity.

During the 2008 crisis, American homeowners walked away from underwater mortgages by posting the housekeys back to the banks. The country’s version of jingle mail may also see borrowers put self interest above their cultural affinity for gold, especially if the value of the collateral drops durably.

Covid impact

Blame it on the pandemic. While employment in informal occupations has normalised, the nearly 19 million salaried jobs lost to coronavirus disruption are proving harder to bring back, according to the Center for Monitoring the Indian Economy. Meanwhile, unsecured consumer credit has dried up, forcing the middle class to monetize its rainy-day hoard.

Families weren’t swayed by Prime Minister Narendra Modi’s previous exhortations to part with their idle 25,000 tonnes -- only 20 tonnes have been deposited with banks in a five-year-old programme to wean the people off gold. It’s because they didn’t fall for the chance to earn interest that they had some capacity for self insurance when a sudden lockdown was announced in March with hardly any fiscal support from the government. If households now lose their gold by borrowing more than they can afford to repay, how will they navigate the next crisis?

Monetising gold

The recent rally that took prices above $2,000 an ounce has prompted other proposals for using gold. One suggestion is for the RBI to transfer its 618 tonnes of the precious metal at cost to the government and repurchase it at 90 per cent of market value, giving the government the equivalent of $31 billion in freshly minted rupees to repair the economy.

But raiding the Reserve Bank of India’s war chest or asking people to deposit their unaccounted-for gold with the government for a few years, a tax amnesty plan Bloomberg News reported last month, are unnecessary distractions.

Monetising gold would be a worthwhile idea if India were facing balance-of-payment difficulties and needed dollars. That isn’t the case: the RBI’s foreign-exchange reserves have soared past $500 billion. Nor is domestic liquidity in short supply. Its just that even before the pandemic, the country was trapped in a multi-year investment funk, which has drained the financial system of its risk-absorbing capital. Tax collections were already faltering, and now they are cratering. The post-lockdown recovery is giving all indications of being a long slog. So while consumers are looking at gold for survival, the government is viewing it as a tool for revival.

But the central bank doesn’t need accounting gymnastics like parting with its gold and buying it back to support deficit financing. Indonesia’s playbook of openly monetising budget shortfalls offers a saner alternative, provided markets can be convinced that temporary print-and-spend would lift future growth (and tax collections) by plugging a part of the capital crunch.

Using the central banks gold to raise resources is no substitute for bolstering the sovereign’s credibility with investors. Pushing households to do the same won’t bring back their salaried jobs and lost income streams. Now that the yellow metal market has blinked, India will hopefully be able to see its options more clearly.

(This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners. Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services.)

Copyright2020 Bloomberg L.P.

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