The Reserve Bank of India (RBI) has reasons to be concerned over large-scale gold imports. The seemingly insatiable appetite for the yellow metal among Indians, almost all of which is imported, is undermining the stability of the external sector of the economy and, through that, the effective conduct of monetary policy, RBI’s chief remit. Between 2009-10 and 2011-12, India’s gold imports almost doubled to over $ 56 billion, the latter accounting for roughly three-fourths of the country’s current account deficit in its balance of payments.
On Sunday, RBI Deputy Governor, Subir Gokarn, proposed the introduction of new gold-based instruments that are aimed at easing the demand for physical gold. His framework had two components. One, design products that convert the existing hoard of physical gold with households into paper securities, while enabling investors to make a seamless exit and entry back into gold, and with rewards linked to future movements in the price of the metal. Two, enable households to earn a return on their fresh savings comparable to that on physical gold, thereby mitigating the temptation to invest in gold per se .
If financial products offering “gold-like qualities”, as Gokarn puts it, are available, it may curb the public’s desire to possess the real thing and, in turn, have a salutary impact on imports. Or, at least that is the theory. But the RBI would be up against the formidable challenge of unseating gold from the pedestal that the yellow metal enjoys in the collective psyche of Indians. Even if that could be assumed as somehow capable of being overcome, a far greater challenge awaits the RBI. This has to do with a more fundamental aspect of financial intermediation that banks are grappling with: How to generate a profit from operations that promises a fair ‘real’ rate of return on deposits and yet keeps interest rates on borrowings affordable enough for fresh investments to take place in the economy. Also, if the additional resources mobilised through the proposed schemes are to be somehow hedged against future movements of prices of gold (they will necessarily have to be structured along those lines), who would act as the counterparty for such risks? Certainly, banks can’t take on that rate risk themselves without undermining their balance sheets.
If the price/rate risk is to be assumed by the RBI, then it puts its own hoard of foreign exchange reserves accumulated over the last two decades or so on the line; betting against the market is never a wise option. But encouraging dematerialisation of gold investments is still a desirable goal, challenges notwithstanding.