Striking gold

The Indian fascination with gold, and its consequences, are not going anywhere, and might as well be accepted. All through our recent financial history, regulators have fought a losing battle, trying to counter and redirect this demand. The only time these efforts worked was when Manmohan Singh, as finance minister, drastically slashed import duties. However, with this duty being reimposed in Budget 2012-13, in order to arrest the worsening of the current account deficit, the old problems have resurfaced. On Sunday, RBI Deputy Governor Subir Gokarn made a welcome recommendation. He suggested that this attraction for gold be channelled into a demand for gold-backed investment schemes, which could potentially stem the need to physically import the metal.

India’s demand for gold has two components. The first is the demand for gold jewellery; the second and lesser driver is gold as investment against inflation. The desire for jewellery has shown a strong resistance to change and cannot really be altered in the short run. Gokarn is pointing towards the second. The RBI’s K.U.B. Rao committee is examining how to mutate gold properties into financial savings instruments. While inflation kills the value of all financial instruments, those for gold retain their value. So the key element to build into the gold-backed papers will be inflation indexing. Successive governments have asked the RBI to independently consider this suggestion, but the bank has been reluctant so far. The proposed instruments, including the modified gold-backed scheme, gold linked accounts, gold accumulation plans and gold pension plans must, however, incorporate this element. If not, investors will deem them less efficient than money spent on the metal, rendering the plans useless.

The other characteristic of gold is its use in financing small-scale industry, which otherwise has difficulties in the range of instruments it can offer as collateral for bank loans. Earlier this year, the RBI had restricted the percentage of the face value of the metal to which non-banking financial companies can offer loans. Similarly, last week the RBI had asked banks not to give loans against the metal except for working capital requirements, effectively making gold mortgage difficult. While Mint Street has a genuine concern, because high gold import puts pressure on the current account deficit, it has to decide whether it will use the metal as an asset that can be deployed or continue to target it as a load on the economy.