Believing, quite literally, that gold is the root of all evil, Indian policymakers have launched an all-out offensive against the yellow metal in recent times.

First, based on the vague suspicion that India’s gold fetish was being fed by the thriving gold lending business, screws were tightened on gold loan companies and their funding sources choked off.

Then, higher customs and excise duty were slapped on all gold purchases. A PAN card was made necessary for jewellery purchases above Rs 2 lakh. Yet, India’s gold purchases after dipping briefly for a few months, have edged up again in the September quarter.

Paper gold doesn’t work

This has the Reserve Bank of India thinking up yet newer ways to curb gold purchases.

Could banks offer some kind of ‘paper gold’ or derivative gold so that the country does not have to actually import gold in order to satisfy its masses? Well, the paper gold idea has been tried, but has not enjoyed great success.

Exchange Traded Funds (ETFs), investing in gold, have been around in India for over a decade. But in the quarter ended September 2012, in fact, Gold ETFs attracted just Rs 500 crore of inflows, even as Indians made jewellery purchases worth Rs 39,500 crore.

Gold derivatives are traded on Indian commodity exchanges, but again haven’t materially dented the appetite for physical gold.

In fact, given that Indians seem so convinced about the merits of investing in gold, it appears best for policymakers to throw in the towel at this stage. Indeed, there is a bright side to the Indian propensity for gold, which they need to sit up and take notice of.

Wealth effect

First, there is the ‘wealth effect’. Had Indian investors sunk all their savings into the equity markets five years ago, today they would be sitting on slightly less wealth than they owned in 2007. For, the Sensex has served up a marginal negative return to investors over this five year period.

Had they invested in bank deposits offering 8 per cent a year, their investments would still have failed to beat inflation. But with gold prices galloping at 24 per cent a year, the jewellery in bank lockers has trebled in value over the same five years.

One can only imagine the effect of this on India’s household wealth, given that our gold holdings exceed equity assets by a factor of ten. Computations show that retail investors have about Rs 5 lakh crore invested in listed equities at current market prices.

Household gold holdings, officially estimated at 18,000 tonnes, represent a whopping sum of Rs 58 lakh crore!

What this adds up to is an enormous ‘wealth effect’. While investors in the West are now worse off with a moribund stock market and near zero interest rates, Indians are in a sweet spot merely because they eschewed the dubious benefits of financial savings for the joys of buying jewellery.

This could in fact explain why consumer spending in India has remained so stubbornly resilient amid economic strife. India Inc may struggle to deliver profits, stock markets may drift, but as long as gold and property prices hold up, it is business as usual for Indian savers.


Then, there is the fact that gold has successfully trounced inflation when every other financial instrument has proved unequal to the task.

In the last five years, as inflation rates have climbed higher, savers investing in fixed income avenues such as bank deposits or small savings schemes haven’t kept up, earning investors a negative real return. Equities, which are supposed to beat inflation, have proved a disappointment, too.

As policymakers have not managed to do much either to come up with inflation-beating investments or to curb inflation, it seems more than a little unfair that they should turn their guns on gold investing -- the only avenue available to the layman to protect his purchasing power.

Finally, one cannot lose sight of the fact that gold also plays a significant financial inclusion role. Not only is it much more widely available and accessible to rural folk than bank deposits or small savings schemes, it allows them to raise emergency money at short notice by pawning it at the local moneylenders’.

If we don’t curb gold imports, what happens to the trade deficit, which is expanding by the minute? The answer to this is that, over the long term, it is not gold, but India’s energy and oil imports which will make a material difference to its balance of payments.

Wrong tree

Gold makes up only about 10 per cent of India’s import bill, while oil imports make up nearly 35 per cent. Curbs on gold purchases may at best reduce the proportion of gold imports to say 7-8 per cent, they certainly cannot plunge to zero.

But investing in gold is simply barbaric, economists may still protest. It owes all its value to mere perception and does not generate any regular returns. Without any measure of gold’s intrinsic value, how does one know if it is in a speculative bubble?

These are valid concerns, but ones that can apply to many forms of financial savings today. Events that have unfolded since the global credit crisis of 2008 have, after all, called into question many of the fundamental assumptions we make about money. They have proved that cast-iron investments like real estate can collapse overnight, that governments can default and that paper money can rapidly lose value.

In fact, it is this loss of faith in the system which has made central banks around the world surreptitiously turn from being net sellers of gold to net buyers in recent years.

Data from the World Gold Council show that central bank buying accounted for a more than a third of global gold demand this year. While US, Germany, France and Italy hold over 70 per cent of their own foreign exchange reserves in gold, others have been racing to pad up their own gold allocations.

The RBI currently holds about 11 per cent of its own reserves in gold, the proportion being much higher than five years ago.

All this makes it rather farcical for policymakers to take a moral high ground on the Indian appetite for gold. The layman will return to financial instruments when he sees them delivering on their promised benefits. Until then, don’t grudge him his freedom to put faith in gold, like central bankers do.