There were a lot of glittering assets at the Fashion Week that just finished — which, amongst other things, turned my mind to those other glittering assets that India has in such abundance.
In fact, recently there’s been a lot of banter about India’s glittering assets and whether they are a burden or a treasure. There’s a school of thought that believes that gold is a “barbarous relic”, that the huge imports are harmful for the economy and should be discouraged by increasing the duty to, say, four per cent. This school came suddenly out of the woodwork when the government recently changed the duty on gold imports from Rs 300 per 10 grammes to two per cent, finally bringing gold (and silver) on to the same ad valorem duty platform as all other imports.
Some from this school argue that if India’s gold imports continue to rise at the rate they have been for the past few years, they would increase to around Rs 3 lakh crore by 2014-15, which would keep sustained pressure on the rupee. A countervailing argument is that since gold imports declined in the third quarter of 2011, India’s demand for gold is declining and will continue to fall. This suggests that imports will come down and the rupee will appreciate.
My view is that India will always have a strong demand for gold — the dip in demand seen last quarter was probably the result of the double whammy of high global gold prices and the dramatically weaker rupee. In fact, in recent years, gold demand has increased beyond that required for domestic consumption (for jewellery and investment) because we are now also significant exporters of gold jewellery — as much as 32 per cent of India’s gold imports are actually re-exported.
Over the past three years, India’s exports of gold jewellery have grown by a cumulative 88 per cent to reach a substantial Rs 65,000 crore in 2010-11. Gold imports grew by a still high, but lower, 64 per cent during the period. Jewellery manufacture is labour- and skill-intensive, and it is one of India’s differentiated skills. Clearly, this industry needs to be encouraged — and so banning of gold imports or increasing customs duties would not just reignite smuggling, but would also be counterproductive for the larger economy.
Again, when assessing the impact of gold on our balance of payments, we need to look at net gold imports (as opposed to simply gold imports). In 2010-11, these were about Rs 1 lakh crore, comprising just 5.7 per cent of total imports and about a third of the current account deficit.
It is estimated that 60 per cent of net imports are used for domestic jewellery and the balance for investment (in bars and coins). It may be reasonable to assume that India’s huge gold stash – estimated at around 18,000 tonnes, which at today’s price is worth about the same as our GDP – is similarly distributed. This suggests that as much as Rs 25 lakh crore of savings are locked up in gold — about half the total capitalisation of our equity markets.
Clearly, the government and the Reserve Bank of India (RBI) need to focus intensely on how to bring at least part of these glittering assets into more productive use. The RBI should enable a liquid paper gold market, through instruments like gold savings accounts (GSAs), gold deposits and gold securities, so that investors could continue to maintain gold savings but without needing to hold all of them in terms of physical bullion.
Gold savings accounts could work like regular savings accounts at banks, where the bank provides its depositors surety that they can get their cash whenever they want, but – assuming reasonable financial stability – holds only about five per cent of cash on hand at any given time. GSAs, too, could be designed whereby the bank would have to hold only, say, 20 per cent of the total value of gold savings in physical form. The RBI would also have to permit a deeper paper gold market with a wider array of instruments to enable the banks (as well as institutional and other investors) to hedge their risk and take positions on the gold price.
To make this happen, the government, in the Budget, needs to ensure that all constraints of stamp duty, sales tax, restrictions of FCRA and SCRA, etc are summarily eliminated for this purpose.
The stakes are pretty high. If we could dematerialise even five per cent of India’s huge gold stash, it would increase our savings rate by around that same amount, dramatically increasing funds for development. Over a few years, the release of “captive” gold could bring about an even more amazing change: India could turn into a net exporter of gold, a situation that prevailed once before – and very briefly – in the early 1930s.