The glittering mirage

The gold price in the US has hit an all-time high of above USD 2,250, which is up about 38 per cent from its last low in 2022. In India, it has reached a new high of above Rs 70,000 per 10 grams, which, according to a report by ICCI Direct, marks a trend of gradual but continuous rise since 2018, contrasting with the relatively stable prices between 2012 and 2018.

The exponential increase in the price of gold in the last few months has become a matter of concern for financial markets worldwide due to possible ramifications on the global economy. The sudden rise in gold prices is attributed to factors like the fall in the Dollar Index, anticipation of a decrease in Federal Reserve interest rates in June, purchases by central banks of various nations, speculation, and an increase in demand from China etc., but no definite cause has been ascertained yet.

According to the World Gold Council (WGC), gold accounts for around 12 per cent of the value of total global reserves as central banks use it as a hedge against inflation to moderate the currency fluctuations caused by economic and monetary policies. Besides, there is still a huge demand for physical gold bars, coins, gold-backed ETFs (Exchange Traded Funds), and over-the-counter (OTC) investments in the financial markets. But with regard to domestic consumption, India tops the list of 13 countries, followed by China, the US, Turkey, and Thailand. Projections by the World Gold Council suggest India’s gold demand may rise to between 800 and 900 tons in 2024, surpassing the previous level of 700-800 tons.

Ergo, India, as one of the largest importers of gold, may need to be cautious since the adverse impacts of rising gold prices may unfold in various ways such as widening of trade deficit, pressure on balance of payments, upsetting the trade balance, depreciation of Rupee, and strain on foreign exchange reserves. Besides, the scenario could also result in an increase in demand for gold loans leading to increased liquidity in the markets, and a horde of problems incidental to. Recently, a survey by Motilal Oswal revealed that household debt levels reached an all-time high of 40 per cent of GDP in December 2023, while net savings dropped to the lowest level of 5 per cent of GDP.

The role of gold in the economy is intriguing. Firstly, with domestic production of gold at only 1 per cent, and recycling at 10 per cent, the remaining 89 per cent of demand is met by imports, the second largest after crude oil, often leading to a Current Account Deficiency (CAD). Gold imports increased multi-fold (22.58 per cent) to USD 7.9 billion (Rs 58,573 crore) during the April-June 2021 quarter from USD 688 million (Rs 5,208 crore) in the same period in 2020, pushing the trade deficit to USD 31 billion. The CAD has widened to USD 8.1 billion in Q4FY21 from USD 2.2 billion in the earlier quarter due to a higher trade deficit and lower net invisible receipts. Importing crude oil is unavoidable, whereas importing gold is embarrassing since it has little or no active contribution to the economy in any sector. Remedial measures like hikes in taxes and duties aimed at discouraging gold imports have only encouraged smuggling; it’s no secret that one-fourth of the total volume of gold entering India is through illicit trade, a vehicle for black money.

It is estimated that more than 80 per cent of the demand for gold is from households, driven by either cultural values or as a store of value, which is one of the factors responsible for the decline in the rate of household savings. Reportedly, around 25,000 tonnes of gold are estimated to be in India, worth nearly USD 1.5 trillion (Rs 1,07,14,500 Cr) based on current prices, mostly in private possession in the form of jewelry, bars, or coins. Even if half of the huge amount of gold (estimated to be 40 per cent of nominal GDP in FY2019) available in the country is monetised, especially during times of economic boom like the present, it would greatly help the growth of the economy and at the same time ensure better returns to people in terms of opportunity cost.

Though considered a ‘safe haven,’ the gains in gold investment are far inferior vis-à-vis stocks, real estate, or production activity. Moreover, it is often used as collateral in the informal credit sector where people are exploited by high interest rates between 15-25 per cent. Then why is it that the demand for gold is on the rise despite its soaring prices? The reasons, apparently, are: the waning trust in financial institutions including commercial banks, erosion of credibility in stock markets, and lack of adequate fiscal empowerment of people. The global meltdown of 2008 and many ‘pump and dump’ scams in stock markets made a dent in institutional credibility, driving people to embrace gold as a safe and secure investment.

However, in the larger interest of the economy, the gold narrative needs to be regulated. To this end, we have a three-fold task to perform: first, monetise the gold lying idle in private possessions; second, encourage alternative investments; and third, restore the credibility of institutions. With regard to the first, a few schemes were rolled out in 2015. Sovereign Gold Bonds (SGBs) are debt funds as an alternative to gold, offering 2.75 per cent interest, which can be redeemed in cash at the market price of gold. However, since the bonds are not secured by physical gold and their price is at a high premium compared to the market price, the scheme couldn’t deliver expected results. The Gold Monetisation Scheme is a modification of the Gold Deposit Scheme of 1999, meant for mobilising physical gold from people’s possession into banks. But the hitch is that since a large part of the gold is not officially accounted for, people apprehend a potential risk of harassment from the Income Tax Department. The other disincentives are an 8-year locking period, unattractive rates of interest, and taxes on the gains. Perhaps an innovative approach is necessary to create more investor-friendly products.

Marketing of alternative products requires the expansion of operations along with increased professionalism. Even Niti Aayog, in its 2018 report on the gold market, emphasised greater participation by banks in the GMS and GML. A number of diversified portfolios promising 10-15 per cent returns with flexible exit options are available in the market. The Portfolio Management System (PMS) is one such product managed by fintech firms. The Gold Saving Account (gold funds) powers digital gold, offering returns in the value of the metal rather than that of the currency. But the problem is they are within the reach of only a section of educated people. Out of around 650,000 villages in the country, only about 36,000 have a bank branch. We need to focus on increasing financial inclusion and fiscal empowerment in order to bring about attitudinal changes in favour of alternative non-gold products. Reforms towards restoring institutional credibility are crucial in the process.

The writer is a former Addl. Chief Secretary of Chhattisgarh. Views expressed are personal