India is the highest importer of gold in the world. During 2014 it imported 843 tonnes, ahead of China’s 814 tonnes. Together these two countries accounted for 54% of global demand in the first quarter of 2015.
India’s demand for gold has grown about 17% per annum for the past decade alone. Since all of this gold has to be imported, the annual outflow of foreign exchange is high, even touching 50 billion dollars in some years. Roughly speaking, most of whatever dollars the country earns from its IT and software exports is frittered away in importing gold.
What explains this insatiable demand? There are cultural reasons, but largely it is plain old economics. If you wanted to park savings for the long term, where would you put them? Ten grams of gold is more affordable and feasible, than buying 1 percent of a flat. Gold is durable and can easily be liquidated in an emergency. Further, gold is perceived to be an excellent hedge against inflation. It is also a proxy for holding a “foreign” asset, which doesn’t debase like the local currency.
Finally, and this is a developing country syndrome, gold is more trustworthy than many competing forms of “paper” wealth. So most households in India, prefer to park some of their savings in the form of gold. This is reflected rather starkly in the national accounts.
India has one of the highest savings ratio in the world. The ratio peaked at about 38% of GDP in 2008, and has now declined to about 31%. A high savings ratio should translate into high economic growth, but only if the savings are completely channelized into new investment, through the banks and financial sector. So what really matters for growth, is the proportion of financial savings. Unfortunately this is very low.
In essence, more than half of India’s national savings do not flow through banks and capital markets. They are locked up in physical form like gold and real estate. Almost 67% of household savings are now in the form of physical savings. Even the money flowing into the stock market is mostly from foreign institutional investors, unmatched in terms of either enthusiasm or magnitude by the domestic retail investor. All told, the country has an estimated stock of 22,000 tonnes of gold which can be considered the cumulative investment of households.
The challenge of turning the tide, of increasing the share of financial savings in India is huge, but not daunting. We need to steadily cut into the hunger for gold, by offering competing products, which offer similar benefits and sense of security. It’s no use saying that over the past 20 years, the return on gold investment is half that of the stock market.
Since the early 1990s, various products have indeed been offered to “wean away” the public from the desire to hold gold. They have had zero success. Of course India does not have the option of simply outlawing the possession of gold, as was done in the United States by President Roosevelt in 1932. That was in the middle of the Great Recession, and the President had sweeping powers and an unprecedented mandate. So in India we have offered gold substitutes. They have been basically of three kinds: gold deposit schemes, gold exchange traded funds and gold loans.
The Union Budget of 2015 introduced the gold monetisation scheme, whose rules were notified this past week. Under this monetisation, you take your gold, in the form of jewellery, coins or bars, to the bank. The amount can be as low as 30 grams. You get it evaluated for purity. And then you get a gold certificate in exchange, which will give you 2 percent interest, and full gold value on maturity. You may also get back your gold, but in melted form. The income from this scheme will be exempt from income and capital gains tax. The gold thus collected can be used as the statutory CRR or SLR requirement by banks. It can also be supplied to the gems and jewellery industry, thus reducing the demand for imported gold.
All the earlier gold deposit schemes, the ETF’s and the current monetisation scheme suffer from one handicap. They require the submission of physical gold and verification of its purity. This severely curtails the scope for widespread adoption. What we need is a pure Gold Demat Scheme (GDmat), which is completely divorced from the physical metal. This would be sold as physical paper or in demat form, much like the Kisan Vikas Patras, through various distribution channels like post offices, banks and even kirana stores. Each unit is equivalent to, say 20 grams of gold, and is sold at the daily price of gold.
Initially the GDmat would have a maturity of six years, at the end of which you get the then prevailing price of gold. So this is an instrument which is gold for all practical purposes (price, liquidity, availability, mortgagability). The government stands guarantee to redeem the GDmat at the prevailing price of gold. Hence the government is exposed to the international price of gold, and has to either make up for its loss, in case gold prices rise, or reap windfall gains, if the price drops during those 6 years. This risk can easily be hedged using derivative options on international bullion exchanges. The cost of risk abatement will be roughly 5 percent of the total value, per year. This cost should be borne through the Union Budget, given the huge potential benefit GDmat can have in reducing gold imports.
The success of GDmat requires sale through the largest network of distributors (much like small savings schemes), and a strong marketing push. Imagine Amitabh Bachchan selling GDmat as “asli gold” much like his campaign for Kalyan jewellers. The procedure for buying GDmat should be as simple as that for Kisan Vikas Patras, with diluted KYC, but requiring either a PAN or Aadhaar id. There is no downside to this, and it can coexist along with the present gold monetisation scheme. It does not involve cumbersome checking for purity of gold deposits. GDmat is an idea whose time has come.
Ajit Ranade is a Mumbai-based economist.