An insatiable appetite for gold

Indians' preference of physical assets to financial ones is a puzzling phenomenon

Trade data on Monday showed India’s gold imports in November had risen to $5.61 billion, up more than six times from $836 million in the same month a year ago. The sharp jump not only widens the current account deficit but has broader implications for the economy. 

In the past few years, households have allocated a larger portion of their savings to physical assets than financial ones. As a result, the latter’s share in the country’s gross domestic product fell from 10.1% in 2004-05 to 7.1% in 2012-13. Also, thanks to a greater portion of savings being allocated to physical assets, the funds that could otherwise have been utilised by companies are sucked out of the financial system.

The shift towards physical assets has mostly been attributed to lower returns from financial assets and high inflation, which has eroded real returns and led to an increase in gold price. With inflation, as measured by the consumer price index (CPI), averaging nine plus per cent over the past few years, real returns on financial assets like fixed deposits fell to almost zero. Investments in stock markets from 2009-10 to 2012-13 yielded lacklustre real returns, too. 

But the situation has changed considerably over the past year, more so over the past few months. First, inflation has come down sharply, with global commodity prices softening. And second, the stock market has risen roughly 30 per cent over the past year. But a sharp rise in gold demand, despite greater retail participation in the stock market over the past few months, is puzzling. 

According to a CRISIL note, “surge in gold imports in November was perhaps led by higher demand spurred by the festive and upcoming wedding season and low prices (Rs 1,176/troy ounce vis-à-vis Rs 1,276/troy ounce a year ago).” The note adds “gold imports could rise to 850-900 tonnes in FY15 from 655 tonnes in FY14”, if there are no further changes to gold import regulations.

However, if the moderation seen in inflation in recent times persists, lowering household inflation expectations, it is likely that gold demand will also moderate, triggering a shift in favour of financial assets.