Tuesday, September 10, 2013

Gold imports - in whose hands do they end up ?

India Together carries this piece which is part of a series on the current economic crisis. It is reproduced below with links to data sources.

The price of gold is now as carefully followed by the Indian investor as the stock indices. Last year, Indians spent a staggering three lakh crore rupees on imported gold and jewelry. This year, the volume of imports has been higher so far and the import bill is set to break last year’s record.

Unable to offer the world adequate goods and services in exchange for its imports, India runs a current account deficit (CAD) every year. The growing deficit is responsible for the sharp Rupee depreciation of the last two years with its accompanying ills. Last year, gold and jewelry imports alone accounted for 2/3rd of the deficit.

According to conventional economic wisdom, such a depreciation of the Rupee is actually beneficial. It will lead to a decrease in imports (because these would have become costlier) and an increase in exported goods (which would have become cheaper and more competitive) and correct the problem which caused the depreciation in the first place.

The realty is more complex. Take the case of gold imports. The accompanying table shows imports by Rupee value (last column) and the average prevailing price (middle column). Gold imports in value terms have soared despite sharply rising prices of the metal in recent years. Gold imports can be characterized as .“price inelastic” – higher prices do not lead to curbing the overall Indian demand

Gold price and imports
Average Price
Rs/10 gm
(Rs thousand crores)

But gold imports are not an exception, in this regard. An examination of India’s imports over the last decade shows that India’s major commodity imports are all price inelastic, including petroleum and fertilizers. (Exploring the reasons for this would be another discussion.) If past history is a guide, rupee depreciation will not curtail the import bill.

Costlier imports from devaluation of the rupee however have extremely negative consequences for the common man, driving up the costs of essential items like diesel and gas, edible oil and pulses and fueling generalized inflation.

It stands to reason that to protect the citizen from imported inflation the government must take steps to restrict imports, particularly of items that are not in the nature of essential commodities or inputs for industry. Gold appears to be a prime candidate in this regard.

The government has been content with symbolic measures on gold such as increasing import duties, which as anticipated, has had the effect of increasing gold prices without effecting overall demand. The argument against tough measures restricting gold imports and sales is articulated by the governments’ economic advisors in these terms.

Gold, it is claimed, is an item of mass consumption, purchased by rich and poor alike and driven by deep seated social and cultural factors. (The gold stocks held in rural India are often brought up in this context.) It is hard to change the buying preferences of the mass of Indians. Restricting gold imports by any means will only result in gold coming in into the country through illegal channels and will increase the “criminality in the system”. Finally, it will also hurt the jewelry industry which employs a large number of people.
To examine the validity of these arguments, it is useful to understand who buys gold in India and for what purpose.

Gold ownership – the contrasting trends

Two sets of data serve to throw some light on Indians relationship with gold. The first is the phenomenal growth of loans against gold jewelry pledged as collateral and the companies in this business.
A Jan 2013 RBI study on gold reports that outstanding loans by banks and non banking financial companies (NBFC’s) have grown between Mar 2008 and Mar 2012 from 20,000 crores to nearly 160,000 crores at a compound annual growth rate of over 55%. The study observes that loans are taken for the short term – from 3 months to maximum of 1 year at interest rates ranging from 12% to 24% amounting to 60-75% of value of gold pledged. The majority of loans are of size Rs 30,000 to Rs 80,000. Loans are taken for agricultural purposes, or medical emergencies, to meet education expenses or on the occasion of marriages or deaths.

Gold loan customers are typically farmers, share croppers, agricultural laborers, small traders and proprietors of small scale industry. They are borrowing against gold as collateral because they do not have recourse to short term credit otherwise. The increasing price of gold makes it more attractive to pawn even the small amount of jewelry they possess. This is a section of Indian society that is pawning its gold to meet its basic consumption needs. The gold pawned can be estimated to be worth 2.5 lakh crores, not far short of 2013 imports of 3 lakh crores!

The second data set is on the quantity of gold imported and the total Rupee cost of those imports.
The accompanying figure shows the quantity of gold imports (left vertical axis) and the Rupee cost of those imports (right vertical axis) over a number of years. (The tonnage and Rupee cost of imports are taken from the Export/Import Database maintained by the Ministry of Commerce. The tonnage values reported in the website for 2002-03 and 2003-04 appear to be incorrect. For these two years, the tonnage is as reported by the RBI study referred above. Incidentally, for other years, RBI figures do not differ too much from the Export/Import database)

2008-09 marks a departure from the behavior of gold imports of previous years. The quantity of gold imports starts rising steadily (except for a slight fall in 2012-13) despite steeply rising gold prices reflected in the sharply increasing spend on gold imports.

How is this type of consumption to be explained?

A pointer emerges from data put out by the World Gold Council, an association representing gold mining companies. Traditionally, gold demand has been almost entirely from jewelry, except for a small requirement from industry. In recent years, there has been a new international trend. Physical gold (in the form of gold bars and coins) has become popular globally as a form of investment starting from 2008, coinciding with the global economic crisis. The investment demand has resulted in pushing up gold prices leading to a cycle of increasing demand and increasing prices.

A section of Indians with deep pockets has also followed the lead from around the world. There are no official figures for how much Indians invest in physical gold (in the form of gold bars and jewelry).  But according to estimates of the World Gold Council, the investment demand in India has grown from about 16% of total imports in 2003-04 to over 35% in 2012-13. The federation representing Indian jewelers (AIGJTF) estimates that 30-35% of gold imports are used for meeting the investment demand in the form of gold bars and coins. Of the approximately 1000 tonnes of gold being imported annually in recent years, 350 tonnes is for investment purposes with most of the rest going into jewelry.

The recent increased interest in gold purely as an investment is also evident from another statistics. Gold Exchange Traded Funds (ETF’s) have been available in India from Feb 2007 but they have seen rapid growth from 2009, increasing by nearly 10 times between Mar 2010 and Mar 2013. Of course, ETF’s represent only a miniscule part of the investment in gold, the overwhelming part being held in the physical form.

Incidentally, government policy over the last decade has actively encouraged gold as an investment through numerous measures including allowing the free sale of gold bars and coins by banks to retail customers, trading in the commodity exchanges with physical delivery and investment in gold exchange traded funds with long term capital gains tax benefits.

We can now return to the arguments of the governments advisors.

The fact is that while the poor may have accumulated jewelry in the past and the middle classes will still be buying jewelry for weddings, it is a small section with disposable income that is buying gold purely as an investment and they account for an estimated third of the imports. Investment gold (bars and coins), with no or little value add by jewelers, has no impact on employment in the jewelry industry. Even the main association of jewelers in India, clearly acting in its own self interest, has called on its members to desist from selling gold bars and coins. As for the fear of gold distribution through illegal channels, it is a bogey routinely raised by economists for whom the “free market” is sacrosanct. Any controls will always invite a few law breakers who must be dealt with according to the law.

It is interesting to note that a precedent for outlawing the possession of gold held as investment rests with none other than the United States. Under a 1933 decree citing national interest, Americans were forced to sell such gold to the US government at a price fixed by it. The limitation on gold ownership was removed only in 1974.

Investment in gold is used by a small minority of high net worth individuals to safeguard their wealth from the ravages of inflation, even as their acts stoke imported inflation further, making life more difficult for the average citizen. Investment in gold – whose price is dollar denominated - has to be treated as a form of “capital flight” that the country can ill afford. Any controls imposed on investment gold can be entirely justified to be in public interest.