At a news conference last week, India's harassed finance minister, P. Chidambaram, addressed the issue of the rising current account deficit and the fall of the rupee against the dollar. His message to his countrymen: Please stop buying so much gold.
Chidambaram has a point. India is the world's biggest consumer of gold, accounting for a little more than one-third of world demand. Traditionally, gold in India has served a double purpose of consumption (it's often the single biggest expense at a wedding) and investment, because it is seen as a more reliable hedge against inflation than savings in financial instruments. Urban and rural Indians differ in their habits in many other spheres, but they are united in their trust in gold. A recent report showed that gold accounted for as much as 10 percent of total household savings in 2011.
Unfortunately, almost no gold is produced domestically, and so rising demand for the precious commodity severely affects the balance of payments. Gold is now the second-largest expense on India's import bill, after crude oil. One would have thought that rising gold prices -- a jump of more 500 percent since 2000 -- would have had the effect of curbing demand, but that's not been the case. As this graph shows, India's demand for gold remained between 550 and 800 metric tons annually from 1997 to 2009, even as prices kept going up.
Here's a market, then, that appears to be price inelastic -- but apparently only when prices are rising. When prices fell to a two-year low in April, gold demand shot up to record levels, with monthly imports averaging 152 tons in the first two months of the new fiscal year, more than twice the monthly average of 70 tons from the previous year. To suppress demand, the government has already raised the import duty on gold twice this year, from 4 percent to 6 percent in January and then from 6 percent to 8 percent in June. Last week, Chidambaram delivered a small homily on gold that was part economics lesson, part supplication:
On gold, I am happy that all my appeals are being heeded partly by the people of India.... Net gold imports averaged 135 million dollars a day in the first 13 business days of May.... However, in the subsequent 14 business days, it averaged only 36 million dollars. So gold imports have sharply come down, but I would be happy if they come down even further. I continue to hope and dream. Suppose we stop gold imports ... suppose the people of India don't demand gold and we don't have to import gold for one year ... the whole situation will so dramatically change.
People who want to buy gold must realize that every ounce of gold is imported -- every ounce. No gold is manufactured in India. You pay rupees, we have to provide the dollars. You think you are buying gold in rupees but actually you are buying gold in dollars. I would once again appeal to everyone: please resist the temptation to buy gold. If we can have it for six months, one year ... it will dramatically change the situation of the current account deficit, and you will see its positive impact on every other index that measures the economy: stock market, exchange rate, interest rates.
Chidambaram is right, as this graph calculating India's trade deficits with and without gold demonstrates. He is by no means the first finance minister to try and persuade his countrymen not to park their money into gold. Last year, his predecessor Pranab Mukherjee, was quoted as saying that the:
Quantum of import of gold ... is a clear indication (that) large section of community ... want investment in dead asset only with expectation that value would appreciate.... Time is ripe to motivate our educated upper middle class to climb from saving mode to wealth generation mode.
This is, however, a long-term project. India's gold-buying culture is deeply entrenched. As Leif Eskesen, chief economist for India and Southeast Asia at HSBC Holdings Plc, wrote in his report "India Perspectives: The Love Affair With Gold" published earlier this year:
Gold imports have always been high in India, which has left Indian households collectively holding no less than 20,000 tonnes of gold, according to the World Gold Council. At current prices that works out to USD4,500 worth of gold per household.
Arguing that investing in gold was for many Indians a perfectly logical decision, Monika Halan wrote in the business newspaper Mint:
I hold the view that the Indian household makes a sensible decision to hoard gold. It is sensible because access to financial assets remains difficult and where access is easy, the regulatory failure to stop large-scale cheating of retail investors ... has broken the fledgling faith in markets for the average investor. Regulatory and institutional failure is the reason people hoard gold and not because they are stupid. And as the country looks more and more unstable, we buy more and more gold—perfectly logical and rational. This is no different than industrialists moving their business overseas and the rich buying real estate and stock abroad.
As the late Indian economist IG Patel, who wrote extensively in the 1950s on India's gold obsession and ways in which to mobilize the hoarded wealth, once said: "In prosperity as in the hour of need, the thoughts of most Indians turn to gold." The evidence from the last few years suggests that when steeply rising prices, and a debilitating current account deficit that raises the cost of other goods, come up against a powerfully entrenched cultural reflex, it's not always the laws of economics that win out.
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