Can inflation-indexed bonds wean investors away from gold?

"The household sector must be incentivised to save in financial instruments, rather than buy gold…I propose to introduce instruments that would protect savings from inflation, especially the savings of the poor and middle classes," Finance Minister P Chidambaram had said in his Budget speech this year.

The Reserve Bank of India is expected to soon bring out the details of inflation-indexed bonds. Though reams have been written about this product, it might not be a bad idea to look at it from a consumer's standpoint. It is vital to check whether these bonds can lead retail consumers away from investing in gold.

Jewellery accounts for about 80 per cent of the demand for gold in India; about 15 per cent is for investment (by way of exchange-traded funds, or ETFs, e-gold, etc). The rest is for industrial use, according to the World Gold Council and GFMS.

Inflation-indexed bonds are complicated products; it would take some time for the market to understand these. Earlier, the markets did not try to introduce these bonds in India. Institutions and pension funds would be the biggest subscribers of these bonds. If inflation-indexed bonds become popular, these could spur innovation in the moribund annuity market, which is expected to take off due to the burgeoning corpus of the National Pension System.

It is possible that the retail market, which invests in gold through ETFs, might shift to inflation-indexed bonds slowly, as it understanding of the product grows. However, as this market accounts for only about 15 per cent of the demand, this is unlikely to have an impact on the overall demand for gold, even if a portion of this shifts to bonds. A scenario in which jewellery buyers would shift to bonds looks unlikely.

There are several reasons. For a retail consumer, it is very easy to buy jewellery. Apart from branded jewellers, every locality has neighbourhood jewellers who cater to the entire demand in that locality, including demand for jewellery pieces worth just Rs 1,000-2,000. Consumers don't need to sign at umpteen places, open an account or show their PAN card. Typically, such jewellers also offer to buy back jewellery over the counter, thus offering much-needed funds when required.

Jewellery also serves as a great social tool for consumers, as it displays the family wealth in a socially acceptable manner. Ironically, the Achilles heel of traditional jewellery purchases is its worth as an investment. High making charges and the widespread practice of providing lower-than-promised purity means the jewellery loses 15-35 per cent of its value as soon as it is bought from a shop. Due to this kind of an up-front hit, the investment won't fare well, irrespective of the gold price in the market.

This is where a rather plausible theory could come into play. A cleverly designed marketing campaign that promotes the worth of hallmark jewellery, or even coins or bars, would shift demand from the high-margin traditional jewellery market. The theory is hallmarked jewellery (for which wide choices aren't really available) and bars and coins (that can be displayed on only a few occasions) have less social significance.

Therefore, an increase in demand for these, owing to the marketing campaign, would be more-than-compensated by the fall in demand for traditional jewellery, which would lose attractiveness as an investment. This would be highlighted by contrasts, rather than by directly attacking a long ingrained belief on the virtues of gold as an investment.

The question is who would fund this rather unconventional marketing strategy, which, on the flip side, has the potential to increase the demand for hallmarked jewellery without affecting the demand for traditional jewellery?