All that glitters

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As gold emerges most preferred investment option, no amount of taxation seems to deter consumers

All that glitters
In planning to curb gold imports as it tries to limit the current account deficit, the government has made a fundamental, erroneous assumption that people buy gold for its flaunt value. Actually, all evidence points to the metal being increasingly seen by people as an inflation hedge, as its value has risen fast when most other asset classes have actually shrunk in value.

This is not the first time the government has articulated its concerns at the volume of money going out due to gold imports. It placed an extra burden by way of import duty on gold last year, the idea being that the metal would get expensive enough to put off buyers.

In January last year, the duty was shifted from volume to value. A levy of 2 per cent on value was imposed (replacing the earlier duty of Rs 300 per 10 gm), and this was doubled within two months to 4 per cent.

In the event, the tactic failed. Gold consumption (and, therefore, import), clearly, has become price-inelastic -- and, by inverse logic, duty-inelastic, too. According to commerce ministry data, 878 tonnes was imported in January-November last year. December 2012 data are yet to be released, but if we assume a monthly average import of 79 tonnes for that month, the whole year’s imports would be no more than 950 tonnes -- very much in line with India’s annual gold consumption.

Going back a little, 2008 saw consumption of 712 tonnes; in 2009 the economic downturn forced this down to 578 tonnes, according to World Gold Council (WGC) data. Rising again, consumption was 1,006 tonnes in 2010 and 1,000 tonnes in 2011. One would note that the volumes did not increase much, but with gold prices going through the roof, the value of imports has gone staggeringly high. The rise had much to do with price appreciation in a period when most other assets classes depreciated. MCX gold gave a return of 24 per cent in 2010 and 31 per cent in 2011 and a lower 12.9 per cent in 2012, a year when Sensex gave a return of 25 per cent. But then, Sensex’s gain was also because of the base effect.

Gold has become a preferred way of investing money; the other side of the coin was dropping domestic savings rates. India’s household savings rate has fallen to 22 per cent of GDP; the rate had hit a peak of 26 per cent in 2007-08. The drop is commonly attributed to the raging inflation that has the effect of making financial savings unattractive. On the basis of the consumer price index, the return on financial savings is negative by 1 per cent. On the basis of the wholesale price index, the return is negative by 3 per cent. Plus, you have to pay a TDS on interest income. What this has done is drive financial savers to physical assets.

And what better than gold? Gold gives no return by way of interest income; what it offers is appreciation in value. In dollar terms, gold prices have given a return of over 41 per cent per year since the year 1900. Few other assets have matched this return. So, is it a surprise that Indian households have gone in for gold in a big way? Studies by various agencies, including WGC, indicate Indian households, religious institutions and trusts hold up to 24,000 tonnes of gold; at current dollar value, this is worth $1.3 trillion, probably the highest hidden reserve any country has.

The hidden reserve continues to rise as inflation-hit households move to gold and away from financial savings. According to RBI’s financial stability report last month, financial savings fell by Rs 1,00,000 crore to Rs 6,90,000 crore at the end of March last year. Since then, there has been little sign of inflation abating or gold prices retreating, a pointer that the migration to gold continues.

As a fund manager puts it, by increasing gold import duties and appealing to cut consumption, the government can’t achieve much, unless exports are increased. Shrinking exports are the singular reason for the billowing current account deficit (6.4 per cent of GDP in the first half of 2012-13). A widening trade gap will weaken the rupee and lead to inflation, which will drive the common man to gold as an inflation hedge. “If the government really wants to control the import bill, it can do so by curbing imports of depreciating assets like electronics, which now account for 70 per cent of consumption,” he says.

And the demand for gold is unlikely to go down in a hurry. Few see international prices receding in 2013. JRG Wealth Management analyst Tapan Trivedi predicts international spot gold to cross $1,920 per oz in 2013 and even touch $2,000. If international prices remain at current levels throughout 2013, Indian prices will be in a range of Rs 28,500 to Rs 33,500 per 10 gm.

Central banks around the globe remain big buyers of gold for much the same reason as the common Indian hordes gold. Central banks of emerging economies, which were net sellers of gold in the past two decades, have turned net buyers since the downturn of 2008. In the past two years, their net purchases touched record levels. In 2011, net purchases by central banks amounted to 439.7 tonnes, highest since 1964. The net purchases in 2011 saw a five-fold increase from 77 tonnes in 2010. As at October end last year, their net purchases were 375.9 tonnes. The largest buyers were Brazil, Kazakhstan and Turkey.

Exchange traded funds (ETFs), with gold as the underlying asset, have contributed to its prices. Institutional and retail inflows into global gold ETFs are at record levels. ETF holdings have been a key indicator of price movements in the recent years. Reports suggest that at November end last year ETF holdings were at an all-time high of over $150 billion. Till November, holdings in ETFs had risen by 12 per cent to 2,630 tonnes. Large investors like John Paulson and George Soros invested in gold in the later part of 2012. Paulson has $3.66 billion worth of holdings in SPDR Gold Trust and Soros Fund Management increased its holdings by 49 per cent in the third quarter.

The quantitative easing in the US and the European Central Bank’s bond-buying programme has further fuelled gold prices. The US Federal Reserve is in the process of injecting at least $40 billion into the global financial system through bond purchases. The European Central Bank is also offering a similar infusion through its long-term refinance operations.

The cash infusion has kept the bullion market bullish. Trivedi says, “Going by the fragile global economic outlook, we expect central bank gold holdings of the emerging economies to remain high in the coming years. These holdings, as a percentage of their total reserves, are still low. Gold holdings of the US and Germany form nearly three-fourths of their total reserves; the gold holdings of emerging economies like South Korea, Indonesia, Mexico and China are still in single digits as ratios of their total reserves.”

The shift of household savings to gold has, however, hit the cash position with domestic banks, leading to tight money conditions and making it difficult for RBI to bring down policy rates. Experts say if policy interest rates are brought down, the flight to gold will not reduce. It will only increase.

The last time strict curbs were placed on gold was in the wake of the 1962 war with China. At the time, the Gold Control Act was enacted to restrict individuals from holding gold coins and bars; whoever had them was required to turn them into jewellery and declare them to the authorities. Goldsmiths were not allowed to own more than 100 gm of gold at a time. There were restrictions even on the holdings of licenced dealers. As a result, an unofficial trade in gold started. Hawala deals, black money and tax evasion became rampant. It took the government three decades to realise the law was not working: the policies were liberalised in the 1990s.

In 1965, gold bonds were floated with 6.5 per cent interest – considered a high rate at that time. But this brought in only 16.3 tonnes from the public. A similar scheme is under way to shore up cash in the banking system and help buffer sagging currency values, but tax issues dog the plan.

The spikes in gold prices and shifting popular preference have jewellers worried. Large price spikes in raw gold cut into their margins. The Gem and Jewellery Trade Federation’s chairman, Bachhraj Bamalwa, wants the government to bring out and lend this gold to jewellers at a nominal rate of interest. “If the government can bring out 10 per cent of the gold hoarding and lend it to jewellers as working capital, India will be spared the trouble of importing gold for at least three years. This will cut the trade gap and bring the gold price down,” he says.

Mehul Choksi, CMD of the Gitanjali group, suggests that this (hoarded) gold can be recycled and used for making export jewellery: “With technological upgradation, several jewellers can make use of the domestic gold reserves, export jewellery and earn foreign exchange.”

High liquidity in gold is also another factor in the shifting preference. Small traders and farmers use gold as collateral to raise working capital. Some banks (private sector ING Vysya Bank being one) have begun to accept gold as additional collateral for granting working capital loans to small traders. Most banks, however, only sell gold coins and bars and shy away from buying gold in a two-way trade.

Motilal Oswal Commodity’s associate director Kishore Narne says gold idling with gold ETFs should also be available for use. Part of the ETF gold holdings can be lent to jewellers and bullion dealers. Banks should be allowed to buy back gold coins and bars they sell. This will help cut gold imports. Or, banks should get out of the gold coin selling business, suggests Narne.

ETFs hardly meet the liquidity need of savers. After all, those who put their money in gold are not confined to urban India. Most ETF buyers live in cities. In rural India, gold as a physical asset is still the preferred choice. Getting that hoard out is not going to be easy, unless the fundamental issues of inflation and liquidity are addressed.

(With inputs fromYogima Seth Sharma in New Delhi)


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