The Union Budget paid special attention to gold. The finance minister outlined a multi-pronged approach to persuade households to stop hoarding the precious metal. Thus, existing gold-loan schemes will be reviewed and tweaked. The government will make arrangements to issue its own gold coins and biscuits to ease pressure on imports. A sovereign gold bond will also be launched. The compulsions are clear: too large a proportion of savings is parked in an unproductive asset that is, moreover, imported. India imports about 1,000 tonnes or more of gold annually, making this the second largest contributor to imports. In fact, the current account would probably be surplus in 2014-15 if gold imports were to moderate just a little.
HDFC Mutual Fund's Chief Investment Officer Prashant Jain recently drew attention to data that highlight how deleterious the obsession with gold has proved. While receiving the Business Standard award for the best equity fund manager, Mr Jain said that in the past 15 years, foreign institutional investors parked $150 billion in Indian equities and India imported over $250 billion worth of gold. During that period, stock market indices gave a return of around 15 per cent a year, while gold gave an annual return of only eight per cent. Hence, India has lost out in terms of investible resources and suffered pressure on the current account, while gold investors have lost out on returns. Each of the proposed Budget initiatives has pros and cons. The devil lies in the details. The sovereign gold bond will be a derivative instrument. Units will be benchmarked to gold prices and fluctuate accordingly in price, while a small interest rate (about two per cent a year) will also be paid. The instrument is to be settled in rupees, obviating the need to import metal. The interest costs will be easily financed by investing the corpus in higher-yield instruments. But this bond also commits to absorbing capital losses in the event of mass redemptions at high gold prices.
Gold-lending schemes already in operation have not proved popular. In these, the investor lends metal, receives interest in rupees and redeems by receiving gold back in the form of biscuits. In theory, lending enables stocks of idle gold to be monetised and used by jewellers, etc. However, much of the idle gold stock has been accumulated with the help of converted black money. Also, no household wishes to hand over jewellery and receive biscuits in return. The new loan proposal would have to be tweaked to take account of these preferences. The success of the third new concept, that of launching indigenous gold coins and biscuits, will depend largely on relative efficiencies. Will it really be cheaper for the Indian government to set up a precious metal mint, or to import customised biscuits in bulk?
The obsession with gold has its roots in Indian customs. But the traditional preference has been compounded by the lack of safe investment options for households. The stock market is perceived as scam-driven; there is no secondary debt market; mutual funds and unit-linked insurance policies have been mis-sold. Finding less damaging ways to satisfy the appetite for gold is no more than treating the symptoms. To change household preferences and persuade retail investors to move their savings back into financial assets, systemic problems across the financial sector must be tackled.
