But the government is resolved to fight this. And so gold has come under attack again.
According to Finance Minister P Chidambaram, had the gold imports been half of the actual level, that would have added $10.5 billion to the country’s foreign exchange reserves.
So he proposes to increase the import tariff of gold to push up the prices, which he hopes will deter the consumers from buying the yellow metal.
In tandem is the Reserve Bank of India. A panel, which was constituted to look into gold imports, has suggested higher import duty on gold import. This is precisely what is on the government’s mind.
The panel has also suggested introducing other products like inflation-indexed bonds to wean away the investors from gold.
It is beyond doubt that Indians’ attraction towards gold has to be curbed. And the RBI panel’s recommendation seems to be on the right track.
For example, while recommending an increase in import tariff it has also cautioned that if raised beyond a level, the move will only increase smuggling. (This has already happened after the government increased import duty in the last Budget)
Another suggestion from the panel is to document gold sales and purchases.
But implementation of these measures will bear fruit only if the government plays its role.
One reason for the increase in investment demand for gold is inflation. So, to curb demand for gold, the first step should be to control inflation. The RBI is already doing its bit on this front, while it is for the government to take steps to address the supply side issues.
Secondly, the government has to introduce steps to make financial assets more attractive than real assets like gold and real estate.
The RBI has expressed its dismay over the decline in the household savings in financial assets.
In FY10, the household savings in financial instruments were 12.2 percent. It fell to 9.3 percent in FY11 and then to 7.8 percent in FY12.
The trend has rung alarm bells and the government, for the first time this year, announced steps purportedly aimed at ploughing back household savings back to stocks and other products.
Sebi has also simplified mutual fund investment procedures.
But these are yet to give the intended results. For, despite a rally and all-round optimism after the so-called reform steps, retail investors are absent from the equity markets.
Moreover, there are signals that demand for gold is only likely to increase this year. According to a report in the Economic Times today, dealers in gold and jewellers see demand rising 10-15 percent this quarter as sales in rural areas are expected to increase.
The rising demand has a pointer to the failure of the government policy in understanding and addressing the cultural reasons for Indians’ penchant.
The yellow metal’s status as an investment in India is almost new found. For most Indians, it is just jewellery, which is by and large linked to social status.
Gold is also an important part of the dowry (psst!!) in most part of the country.
So, how far will the government’s initiatives and the RBI panel’s suggestions be effective in addressing such issues? Very little.
As long there are no steps to tackle such traditional and conservative customs still prevalent, gold will remain key for Indians.
On top of all these is the issue of black money. The main attraction of the real assets is that they are an important avenue for those looking to channel their black money.
On the government’s resolve to curb the black money flow, less said, the better.
Gold is money: Why can’t UPA’s thinktank understand this?
In an interview, Dr C Rangarajan, Chairman of the PM’s Economic Advisory Council (PMEAC), explained the rationale as to why Indian citizens should not be buying copious quantities of gold. It appears he was a bit oblivious to the reasons why Indians buy gold and so I thought it would be worthwhile to point out the same. Before I explain the economic reasons behind why citizens buy gold, it’s perhaps indicative of the state of affairs that interviews by our economics team provide more entertainment value than an educational one.
In fact, I have been scratching my head to pinpoint the last interview by any bureaucrat or a politician on the subject of economics that made sense. I am yet to come up with one – and this inspite of the soft-ball questions that are asked of them by the media. Adam Smith would be turning in his grave if he were to listen to these interviews.
With that little digression, here are the reasons why Indians buy gold.
Historical price record: In the last 40-plus years of history in which gold has functioned as a freely traded commodity, there has never been an extended period of five years or more in which gold has not delivered a positive return in rupee terms. Even during the infamous “gold cliff” period of 1981-2000 in which gold prices declined by more than 70 percent in dollar terms from $850 to a little over $250 an ounce, gold prices more than doubled in rupees.
Currency debasement has been an unwritten policy goal of the Reserve Bank of India and the government and citizens understand that very well. So when Rangarajan says a “certain amount of gold demand is built into the Indian psyche”, the culprit for the same is the RBI.
Of course, Rangarajan did mention inflation hedge as one of the reasons why people buy gold. But in the same breath he also mentioned that Indians purchased $66 billion worth of gold last year and this was $20 billion more than in the previous year. That is a wrong way to look at gold – if you accept that gold is an inflation hedge, then one ought to compare quantities imported rather than the dollar value of the same.
If you do not understand why that’s the case ask any Indian wife who has had the experience of “dowry” and they will tell you it’s always about fixed quantities of grammage and not measured in any currency units. That’s the fundamental point about gold being an inflation hedge.
Given the 40-year track record and the fact that there is not even a remote indication of a policy change, why should we do anything else?
The economic teams doesn’t inspire any confidence whatsoever: Whenever we listen to speeches or interviews of the government’s economics team, it really reflects a very sorry state of understanding of economics by our policymakers.
Take the very simple concept of the relationship between GDP growth and inflation. Every person – and the list includes the who’s who of the so-called reforms team, from Manmohan Singh to Montek Singh, YV Reddy, Pranab Mukherjee, Bimal Jalan, D Subbarao, and Kaushik Basu, et al – has stated over and over again that inflation is a result of the high GDP growth of the last few years. The economic truism is the exact opposite: GDP growth leads to falling prices and not increasing prices, as everybody says.
In fact, this is such a fundamental concept that an undergraduate exam in economics should have the above as the litmus test. Instead, we award such abject ignorance with PhDs and make them central bank governors, finance ministers and heads of finance commissions and planning commission.
So why do you think we should place our faith in the economics team when every objective pointer indicates otherwise?
The interest rate issue: When consumer price increases are in double-digits and the after-tax savings rate offers negative returns by a few hundred basis points, asking for a rate cut should be the equivalent of economic hara-kiri. And yet, that’s precisely what every policy maker and industrialist seems to argue for – each for his own reason and his own pretext. Rangarajan’s reason for asking it is that non-food inflation has moderated.
This kool-aid thinking, that a “rate cut would revive growth,” is as fallacious as the belief that “growth causes price increases.” Our growth bottlenecks are policy logjams and bloated government expenditures that crowd-out private investment and the Javert-like bureaucracy that stifles innovation. A rate cut at this stage, even by as much as 100 basis points, would directly result in higher consumer prices without having any impact on growth. That said, it looks increasingly likely that we will get a rate cut.
Under these conditions, what options does an average saver have?
Global economy @ tipping point: The credit crisis of 2008 should have really resulted in a major clean-up and deleveraging of the system. But predictably, when you have people who did not foresee the issues proposing the solutions, they invariably tend to make the underlying problems bigger while temporarily obfuscating the symptoms.
Economic conditions worldwide seem propitious for another blowout in 2013-14 and gold would prove to be the ultimate hedge under these conditions. With Basel III rules in place, wherein gold moves from Tier 3 to Tier 1 with 100 percent reserves status, there would be a scramble for gold by banking institutions that could catapult gold prices.
Is there any reason to believe that the underlying issues that have been driving gold prices higher have been resolved?
And, of course, gold is money: When Rangarajan, or for that matter, Chief Economic Advisor Raghuram Rajan, say that people are making a dead investment in buying gold, you couldn’t be more wrong if you tried. People are not buying a “barbaric relic with money” – they are buying “money with paper”.
Given that the government has been working over time to reduce the consumption of gold, the gold report itself that came out was not as bad as I would have expected. Just that, instead of using data from the CPM group, which is increasingly turning out to be a propaganda arm of the US Fed, I wish they had used the data from GATA and other private sources. At the very least, one should consider and use more than one source of information in such critical issues.
Of course, given where I think gold prices are headed this decade, the current account deficit (CAD) issue is only likely to get bigger and bigger over the next few years. And none of the solutions proposed by the government’s economic think tank would even provide a semblance of relief. The best is to get somebody who understands these issues to head the RBI.
In that context, may I suggest Jim Grant? No less a person than Ron Paul considered him a potential replacement for Ben Bernanke at the US Fed. Given the perilous times that lie ahead, it’s time we made some difficult-but-rational decisions on the monetary front. There’s no better starting point than getting somebody who understands the issues.
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