The country is facing a deep crisis and the Finance Minister and the Prime Minister are deeply worried. The Finance Minister has also made several road shows abroad hoping to attract FDI and FII investments which are very crucial to manage the Current Account Deficit (CAD) which had gone beyond 4%. The CAD problem is exerting a pressure on the Rupee- Dollar parity and the rupee depreciated to go beyond Rs 61 to a dollar. India is a net importer country. Our largest item of import is oil.
The second on the list is gold. Oil is something which is crucial to transportation and is the something which we cannot cut down. Maybe once Reliance after partnering with BP finds more gas we will have a cheap alternative but as of today it is the costliest and the largest item of our export bill.
India is the largest importer of gold in the world. Whether it is a wedding or a good harvest or to beat inflation, Indians first and foremost think of gold. India needs to import gold and this eats up precious dollars which are routed into the country through FII and FDI investments.
The Government of India has raised the import duty on Gold from 2% to 8% in order to reduce demand but has met with limited success. On a black Monday, the price of gold fell in the international markets from Rs. 32,000 (rupee denominated) to Rs 25,000. This was because the Federal Reserve of USA hinted that they would be tapering off their US$ 85 billion a month bond buying programme which they have termed as Quantitative Easing (QE). In addition to this Cyprus announced its intention to sell its gold reserves amounting to 11 tonnes.
Thirdly, three banks had shorted gold. When the Federal Reserve of USA did its QE programme, it had hoped to revive the US economy and create more jobs to take care of the rising unemployment. This QE money helped the American economy to a limited extent and found its way into the stock markets of BRICS (Brazil, Russia, India, China, and South Africa) countries along with ASEAN countries like Thailand and Indonesia. Gold and dollar have had an inverse relationship for most of the century barring a few exceptions on the onset of the European crisis.
Since the dollar was weakening on account of the increased supply on account of the QE, people started to invest in gold and gold prices soared touching an all time high of a little more than Rs 32,000/- in India. If we think from the angle of an FII, the FII would not be investing in either the American or the European stock markets as the economies were in deep recessions in USA on account of the sub-prime crisis and in Europe on account of the sovereign debt crisis. They would also not invest in dollars as loose supply of dollars meant that the returns would be negative as prices would continue to fall. So these investors turned to emerging markets and to gold.
So the stock markets of emerging markets soared and so did the price of gold. On the black Monday, when prices of gold fell from Rs 32,000 to Rs 25,000 investors in India sold their holdings in Gold ETFs (Exchange Traded Funds). But subsequently, newspapers and TV channels had an interesting story to tell. What happened was investors in India saw the prices at Rs 25,000 and saw this as a buying opportunity- So they rushed to jewelers and to banks to buy physical gold. Jewellers and banks sensed this opportunity and sold gold not at the international equivalent of Rs 25,000 but at higher prices of Rs 28,000 to Rs 29,000 and sometimes even more.
As reported earlier in this article, the Government of India has raised its import duty from 2% to 8% but even then it was reported in newspapers and TV channels that we have already imported in one quarter of 2013 what we had imported in one half of 2012. The RBI and the Gold Council and the Government are trying to find ways to curb gold imports in order to control the current account deficit. Since USA and Europe are still in trouble, exports from India will remain sluggish and are not expected to improve drastically in the short term.
That leaves us with the solution of trying to curb imports. The Reserve Bank of India was concerned about the bubble in gold prices and the mushrooming of gold finance companies in India and it announced a slew of measures so that the Indian economy does not suffer when the prices drop. It had some time back announced that the gold finance companies would not be allowed to give a loan of more than 60% of the value of gold in the gold ornaments pledged. This was done as it had correctly anticipated a fall in gold prices and wanted the gold financing companies to be protected and not have rising NPAs.
Various schemes have been sounded to make gold a more productive asset. One of the schemes has been forthcoming from the President of the Gold Association. He is of the opinion that people should be encouraged to deposit their gold with the Government of India. The Government of India will pay some interest on the deposits and return the gold later. This he feels would curb imports. While this scheme will work well for gold bars and coins but it will not work well for gold jewellery.
People in India are attached to their gold jewllery and while they would be happy to earn interest on their gold jewellery they would demand their jewellery back and not just equivalent gold. Jewellery in India is passed down from one generation to another and even now people pledge their gold to take loans only as a last resort. Some fine tweaking of this scheme is of the order and maybe we will really be able to curb imports.
