The logic goes like this. The Indian lust for gold has caused a tsunami of gold imports. That has dented India’s current account with a huge hole. The current account deficit has brought the rupee to its knees. QED: Gold, which has derailed the rupee, is India’s villain.

Based on this rationale, the Government has renewed the psychological and fiscal war against gold that had been halted in the early 1990s. But is the perception that gold is the main cause of India’s woes on the external sector, right? Is the fall in rupee value due to the rise in gold imports? Had gold imports not risen, would the rupee value have not fallen?

A scrutiny of the numbers reveals that it is the unprecedented capital goods import of $587 billion in nine years of UPA rule, red-carpeted by the UPA with tax cuts and zero-rated tariff structures, which disfigured the current account with a total deficit of $339 billion.

The damage to current account from net import of gold ($161 billion) and oil ($515 billion) seems far less. Besides disrupting the current account, capital goods import has sent the nation’s growth into ICU (See ‘The elephant experts didn’t see, Business Line , September 5, 2013). How is it then gold is demonised as the sole villain? Because modern economics brands gold a “barbaric relic”.

Double trouble

Modern economists and the Indian people seem to operate on two different paradigms with regard to gold. In the modern West, gold is more a state asset than a private possession. Gold constitutes just three per cent of family wealth there, but a third in India. Western states, socialist or capitalist, expropriated all private gold during the last century. Even the liberal US outlawed private gold in 1936 and built official gold reserve of over 20,000 tonnes by 1950.

Modern economics views gold as an uneconomic, wasteful, private investment. But traditionally, in India, gold has been the preferred asset of the rural masses who hold 70 per cent of the nation’s stocks. Indian gold habits clearly mock at modern economic theories.

Market Oracle, a UK-based market analysis and forecasting online publication, captures the relation between India and gold thus: Indians own 20,000 tonnes of gold worth $1 trillion — almost half of India's GDP. For Indians, gold is not just money or asset; it ensures the financial security and stability of families. It has religious overtones. More than a commodity or money, it is integral to the warp and weft of family life. Investments in gold and jewellery are indistinguishable. Jewellery is the working capital of families; families collateralise it for commercial borrowing.

Some 13 per cent of Indian families, more from rural areas, borrow against gold as collateral; while rural India borrows from the unorganised financial sector, urbanites access bank loans. The authors of Market Oracle seem to understand India’s family-gold nexus better than Indian policymakers. Yet, despite such a paradigmatic difference, economic laws on gold based on the Western experience are continuously being tried out in India. Result: the establishment hates what the people love.

Signs of rethink

However, there are indications of rethinking now. Echoing the Market Oracle logic, the Reserve Bank of India Working Group to Study the Issues Related to Gold Imports and Gold Loans by non-bank financial companies under K. U. B. Rao (January 2013) says that “demand for gold appears to be autonomous and a function of several influences and factors that may not be strictly amenable to policy changes” — an admission that gold demand ducks economic theories and policies.

Again, says the study, “gold demand is price inelastic” — meaning gold buying does not reduce if prices rise. It warns that if the official supply of gold is restricted by import curbs or extra taxes, “the buyers take recourse to unauthorised channels to buy gold”.

Now, recall that India had banned gold imports for almost four decades till the early 1990s. But smugglers ensured an unfailing supply. Result: the gold economy functioned underground, generated black money and, in turn, was funded by black money. The Government’s dislike for gold did not make Indians love gold less.

Keeping the the bitter past in mind, the RBI working group sensibly acknowledges that it is impractical to restrict the import of gold. Does it not mean then that the UPA government’s present measures to make gold imports costly would only make smuggling gainful? If the Dawood gang can land deadly explosives on Nariman Point with ease, will it find it tougher to bring in gold?


But, are Indians fools to have invested in gold as the economists would have us believe? No. Actually, gold seems to have fooled the economists. The RBI working group study finds that gold has outperformed stocks and bank deposits in the last five years — more than three times over Nifty, six times over bank deposits and 10-year government bonds. Only gold, no other asset, has so consistently beaten inflation.

The average inflation during 2001-02 to 2005-06 was 4.7 per cent but gold yielded 9.2 per cent — almost double. The average inflation for 2006-7 to 2010-11 was 6.7 per cent but the yield on gold was 23.7 per cent — three times plus. Average inflation for 2012 is 9 per cent but gold returned 33.5 per cent — almost four times. Traditional India intuitively seems to understand the value of gold.

Says Y. V. Reddy, a globally celebrated central banker: “The real purchaser of gold is typically a peasant.” Close to 70 per cent of gold jewellery is sold in rural areas and most gold sales are by way of jewellery. To quote Jeffrey A. Franks, “Holding gold has, in fact, often in history served, from France to India, as the only way the peasant can protect himself against inflation and the vicissitudes of politics”.

Finally, while trillion dollar gold is the real asset of the Indian masses, the trillion dollar stock market capitalisation is the phoney wealth of the Indian classes, dependent on the QE announcements of Ben Bernanke.

Sensible advice

The RBI study, therefore, sensibly advises increased monetisation of gold — to make unaccounted gold generate accounted money. It suggests setting up a bullion corporation for lending against and refinancing gold, and pool and trade in gold stocks. The study commends encouraging gold loans by banks and non-banking institutions.

This is what traditional pawnbrokers have been doing for ages. The State began curbing, instead of registering and disciplining, private moneylenders. The hope that banks would replace them has been belied. An RBI study found that in rural lending the share of institutional agencies declined from 64 per cent in 1991 to 57 per cent in 2002 and the share of the rest rose to 43 per cent, with that of moneylenders, from 17.5 per cent to 29.6 per cent – up by 70 per cent.

In the liberalised financial regime, private moneylending has been rising. Evidently, banks are unable to match private lenders in reaching the needy. The study recommends registering private moneylenders.

Now look at what the Economic Census 2005 says about how 41.2 million non-farming businesses of India — over 60 per cent of which are owned by OBCs, SCs and STs — are financed. These millions of businesses employ 102 million people. Yet only 9 per cent of their capital needs are met by organised finance; 91 per cent is funded by families and private financiers. The undervalued private financial institutions and the discredited moneylenders are the main sources of finance for the largest employment provider of the country. And the collateral for their loans is invariably gold.

Nothing like gold

There is no collateral, stocks or real estate, as liquid as gold in India. How can gold, so valuable a security for productive credit, be dismissed in India as a “barbaric relic”?

The economic establishment wails that gold does not obey its policies. Gold defies government policies because of the disconnect between the polices and the people. Indians revere, not simply love, gold. But the State policies are founded on the economic theories of the West which treat gold like any other commodity for trade and profit. It is no surprise that the theories, which work in the West but not here, project gold as India’s villain.

Yet, gold has emerged as the winner in economics — successfully hedging inflation and beating the stocks and banks. With the unalterable basic facts about gold in India known, the real challenge is how to frame a practical and workable policy for gold and how to ensure that gold imports do not affect the macro economy. Gold buying by Indians is seen as weakening India. But buying is economic power as well — in fact, the ultimate economic power is a nation’s market. Yet, surprisingly, India has not put to use its enormous power as one quarter of the world’s retail market for gold. India has to strategise and use its huge market to overcome the weakness of its people for gold. How to do it is the challenge and a topic by itself.

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