The Indian obsession with gold is well known. From newlywed brides adorned with gold jewelry weighing into the pounds, to devotees showering temple idols with gold for redemption, Indians have historically invested a large part of their savings in this precious yellow metal. In urban and rural areas across the country, gold has long been a prudent, reliable investment. Estimates suggest that 78 percent of Indian household savings are held in gold.
India’s fascination with this commodity means that the country now holds more than 20,000 tonnes, making it the world’s second-largest gold consumer after China. Alongside the Indian penchant for gold ornaments, demand for gold bars and coins has also remained high as an investment option for the vast majority of the population. Instead of financial savings instruments, Indians prefer to invest in physical assets - and unsurprisingly, gold tops that list, along with real estate.
For decades, in a country where the majority of people had limited access to formal banking facilities, the precious yellow metal was viewed as liquid cash. It could be bought or sold with minimum documentation, which added to its appeal. Gold was widely used in the remotest corners of India as an inflation hedge and as an insurance policy to be resorted to in case of a financial emergency.
With participation in domestic Indian equity markets coming primarily from foreign investors and retail participation remaining poor, there have been limited investment options for Indian consumers. There are low real returns in line with high consumer price inflation, which has been consistently higher than benchmark interest rates, resulting in negative real interest rates in bank deposits and government yields in many phases before 2014. This has meant negative returns to the depositor, when adjusted for inflation. Faced with few alternatives, physical assets such as gold and real estate have remained the more popular investment avenues. Gold prices rose every year between 2002 and 2011, providing handsome returns to those who had invested in the commodity.
The huge demand for the material in the form of gold bars and coins among investors and speculators is also believed to be a way of storing wealth without paying tax. Along with real estate, gold has remained an asset class that the authorities struggle to monitor. Moneylenders have given way to registered financial firms and gold loan companies which provide low-ticket gold loans within minutes and with minimum documentation – a very easy way for the vast majority of the population to borrow loans when compared with a formal banking set up.
The huge boom in gold has also closely tracked a boom in black money and corruption over the past decade. The gold market is driven largely by cash transactions, making it a convenient place to park undisclosed black money.
Hence, over the years, the gold craze has played out as an aggregate disaster for the Indian economy. Building up savings in gold, rather than deposits in banks, has created a permanent drag on India’s growth.
Gold diverts savings out of the formal financial system, where they can be harnessed for productive investments. Thus, while India’s overall savings rate is high, a majority of these savings have been diverted to physical assets. These are unproductive in nature when compared with financial saving instruments, which help the economy by boosting spending in infrastructure.
Furthermore, since the country imports a majority of its gold, this fascination with it has weighed heavily on the Indian import bill. Consequently, there is an immense pressure on the country’s current account deficit. Successive Indian administrations, concerned about its impact on the country’s currency and trade balance, have been trying for years to weaken gold’s prominence in the economy. Starting in the fiscal year ending March 2009, India’s consumer price index rose by 8.9 percent or more per year for five consecutive years; gold imports increased in turn, from $17 billion in 2008 to $56 billion in 2012, severely affecting the country’s import bill.
In order to counter the soaring demand and divert investments into more productive assets, the Indian government raised taxes on imported gold three times, to 10 per cent, in 2013, which now makes India the most expensive place in the world to buy gold.
Amid this constant tug of war, the government’s recent decision to demonetize almost 86 percent of its currency has also had an impact on gold. According to reports, soon after the announcement that 500 and 1,000 rupee notes would cease to be used, people rushed to buy gold from jewelers in cash without providing a permanent account number and backdated bills for high-value purchases. There were also reports of illegal money launderers accepting old 500 and 1,000 rupee notes for a premium, earning hefty commissions. Jewelers sold 15 tons of gold ornaments and bars, worth around 50 billion rupees, on the night of November 8 to 9 after the demonetization announcement, which amounts to over a fifth of the monthly sales of gold in a normal year.
However, the Income Tax department subsequently conducted a series of raids in major Indian cities following leads on certain jewelers and dealers. A crackdown on many jewelry shops that were flouting official restrictions took place. Simultaneously, rumors of a gold ban started to circulate, which led to agencies ramping up their gold import volume.
The actions of the tax man seem to have put pressure on domestic gold prices. Since rising to above 31,700 rupees per 10 grams on November 9, the gold rate has now dropped to less than 29,500 rupees in most major markets across the country.
Overall, the rush to park idle cash and the rumors of an impending ban led to a jump in the import of gold to around 100 tons during November, the highest since 2015. However, the same volume hasn't been absorbed and a significant amount of the imports remain unsold, which is likely to result in lower levels of gold imports after December. These factors may also lead to weak demand later in 2017.
Interestingly, this string of actions by the government, the most significant being demonetization and the subsequent crackdown on black money, may ensure that India’s favored yellow metal loses its allure in the short to medium-term, with most opting to divert their savings to the stock markets and financial savings instruments.
The author is a freelance Indian business journalist. She has covered business and finance for the Hindu Business Line, reporting on topics such as banking, insurance, education, and healthcare. Currently, she also works as a communications consultant for Bajaj Allianz General Insurance.