S Gurumurthy

India can win the gold game

S. GURUMURTHY | Updated on December 26, 2013

Alluring to the consumer in good times and bad.

To evolve an India-centric policy on gold, it has to be conceded that Indians will continue to buy gold as long as the world supplies gold to India.

Once again, Finance Minister P. Chidambaram has appealed to the people of India to keep away from gold. As the finance minister, Chidambaram thinks buying gold hurts the nation. But as a lawyer, perhaps he would see no wrong if gold is imported for gain. On June 7, 2003, Chidambaram had given legal opinion to a gold dealer (Gold Quest International Limited) that the State Trading Corporation of India was contractually bound to import supply gold to the dealer. Later, the dealer, allegedly involved in gambling, became bankrupt and investors lost thousands of crores. It became a public scandal leading to arrests and criminal cases.

Precept and practice on gold thus diverges in India. In classrooms, economists trash gold as anachronistic and celebrate stocks as real wealth yet keep their money invested safe in banks, property and gold in that order, not investing a dime in stocks. This is how Indian economic theory preaches against gold, but practice works the other way round.

Even as policymakers congratulate themselves for having controlled gold imports, they find to their horror that smuggled gold, supported by the crime world, sneaks into India. The RBI has rightly confessed that gold is not amenable to policies.

Simple difference

A look at the history of gold control by governments explains why gold control policies work in the West but not in India. In the West, governments — whether democratic or autocratic, socialist or capitalist — long back robbed the people of their gold, nationalised it and made it a State asset. There is no private gold or culture of gold in the West. It is a State monopoly and has long ceased to be the people’s preference and personal asset. It is just another metal for investment.

But that could never happen in India. While three-fourths of the gold imported into India is for jewellery, only a fourth is for investment. No seer is needed to say that economic theories on gold developed in the West are inappropriate to India. Indian needs a home-grown theory.

To evolve an India-centric policy on gold, it has to be conceded that Indians will continue to buy gold (officially imported or smuggled) as long as the world supplies gold to India. If there is no gold in the world, what Indians will do is a hypothetical question.

India imports a quarter of world’s gold supplies; this is regarded as a curse since it dents India’s current account. But the establishment thinkers have never asked themselves what would happen to the world gold market if India did not need imported (or smuggled gold) for a year. The answer is obvious. The world gold market will crash. Who will benefit from the crash? Unquestionably India, as Indians will spend less in dollars for gold.

Indian demand

One good thing, as the Bureau of Indian Standards (BIS) notes, is that Indians do not buy more gold because it is cheap. Nor do they stop or buy less because gold is costlier. But if Indians become prosperous, says the BIS, they buy more gold. So, cheap gold does not entail more gold imports. It just means less outgo of forex.

Indian gold demand causes high gold prices in the world market. Who then is capable of bringing down the world gold prices other than the biggest buyer of gold in the world — namely India itself? If India’s gold imports fire up world gold prices, India cutting imports will bring down gold prices.

But, India can decisively influence gold prices if, and only if, it has guts and acts strategically. First, it must aggregate its gold demand by canalising its import through banks and stop private import of gold. Second, it must sell gold at global rates plus 10 per cent to anyone in India. Third, it must build adequate strategic buffer stock of gold so that it can potentially and even actually stop or cut imports and use the buffer stock to meet domestic demand. This will empower India, the largest importer of gold, to bend the world gold prices.

But wherefrom and how will the government of India build a strategic buffer stock of gold? Here lies the challenge.

Strategic stock counts

Estimates of stocks of gold with Indians range from 20,000 to 40,000 tonnes. Therefore, India lacks not gold stock, but strategic stock of gold with government. Data shows that the share of investment gold — namely unornamented gold — which used to be between a fifth and quarter of the stock in the past, has risen sharply of late. But assuming that only a fifth of the stock is held as investment in India, gold in non-jewellery form will be 4,000 tonnes on the lower side and 8,000 tonnes on the higher side.

The Indian government can build a strategic buffer stock of 3,000 tonnes of unornamented gold by issuing bonds to be subscribed by gold holders in India, returnable to them as gold on maturity.

Once this happens, by using, or even by signalling the use of its buffer stock to stop or reduce gold imports, India can cause a glut in the world gold market and bring down prices. India can also cartelise with China and both, accounting for half the world’s demand for gold, can virtually fix gold prices. India can force down the gold prices, plan ahead and buy and add to its strategic stock of gold. The more the buffer stock, the more will be India’s capacity to handle the world gold market.

The RBI earns a pittance on its forex holdings. If it begins trading in gold and is backed by a quarter of the world’s demand, it can gain enormously on what it invests.

The gold game can thus easily come into India’s hands. Western countries cannot play the gold game because they cannot sell gold domestically.

At the current international price of $35 million a tonne, the value of gold held as investment in India would be between $140 billion and $280 billion. If India builds 3,000 tonnes of strategic buffer stock in RBI’s hands, that would add some $140 billion of forex and take the forex reserves to over $420 billion. This will vastly improve the quality of forex reserve. The present forex reserve which largely comprises FII investments and NRI deposits is too fragile to protect the rupee. The improved forex reserves will stabilise the rupee whose volatility is traceable to hot money flows in and out.

Likely obstacles

But building strategic buffer stock by issuing gold bonds may hit two roadblocks. One, most gold stocks in India are unaccounted. Two, the people will not trust the government with gold. People will disclose and part with their unornamented gold only if full tax immunity is offered.

The scheme is most likely to work on the carrot and stick logic: if the government gives time-bound immunity for the deposit of gold in bonds and penalises those who do not disclose and deposit with confiscation and taxes.

Next, to make people confidently part with their gold, constitutional guarantee for return of gold for gold must be provided. The gold bond should be issued by state-owned banks and must bear attractive interest to entice the people to invest. The bonds must be transferable and accepted as collateral for loans.

Ultimately 90 per cent of the gold collected by banks through issue of bonds must be acquired by the RBI with an obligation to sell it back to the banks to return gold to the bond holders.

The sale of gold to the RBI will add to the lendable funds of the banks and enable them to pay interest on the bonds.

This will have the effect of monetising and securitising gold but the expanded money supply will be no different from the expansion of money supply when the RBI acquires the forex represented by FDI or FII inflows. The money expansion through gold sale by banks to the RBI may be applied for infrastructure.

However, the most critical condition for the success of the scheme is tax immunity for gold bonds — which is a contentious political issue.

This strategy has the potential to transform India into a powerful player in the global market and not remain a weak spectator or a helpless victim as it now is. This is the way — and the only way — for India to win the global gold game. It calls for India-centric thinking. Will the policymakers start thinking afresh?

(The author is a commentator on political and economic affairs, and a corporate advisor.)

Published on December 26, 2013

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