India consumes almost one-third of the world’s gold production. India was hailed as the ‘Land of the Golden Sparrow’ by the Romans, some 300 years before Christ. Twenty-four centuries later, India’s obsession for gold has not waned.
While the combined gold reserves of all the central banks in the world in the second quarter of 2021, as per World Gold Council, is about 31,103 tonnes, privately held gold in India in 2015, was estimated to be 20,000 tonnes, as per the 2015-16 Budget speech by the then Finance Minister, Arun Jaitley.
The Corruptible Lure of Gold
“India was known as the land of the golden sparrow because Indian merchants sought only gold from the rest of the world, which seemed to have an insatiable appetite for Indian textiles and spices,” writes Devdutt Pattanaik, in his book, Olympus.
It seems that we have inherited our ancestors’ fascination for the yellow metal, as gold import reached almost 20 per cent of India’s total import by FY 2012-13, which had severe implications for India’s current account deficit. Growing deficit led the United Progressive Alliance (UPA) government to impose restrictions in the form of five-fold hike in import duty on gold from 2 per cent to 10 per cent. Since FY 2013-14, gold forms about 7 per cent of the total imports by India, according to data from the Department of Commerce.
Though, officially gold import was stable around 7 per cent, a big shadow market emerged on the back of higher import duties. As per the Gold Council of India, between Q3 2013 and Q4 2014, around 335 tonnes of gold was smuggled into the country, which is equivalent to around a quarter of India’s total annual demand. Every year, around 150-200 tonnes of gold gets smuggled into the country, as per a report by the Directorate of Revenue Intelligence (DRI). In FY 2020-21, India imported over Rs 2.5 lakh crore worth of gold, 75 per cent of which was consumed as jewellery.
The Gold (Control) Act, 1968, which prohibited the import of gold except for jewellery, had led to the emergence of a notorious network of gold smugglers during the 1970s and 1980s. When the Act was repealed in the 1990s, following economic reforms and liberalisation, a modest specific duty was charged on import per 10 grams of Standard Gold (of purity 99.5 per cent and above). The specific duty on gold import was Rs 200 on 10 grams in 2010-11 which was increased to Rs 300 in 2011-12. The gold smuggling operations almost came to a grinding halt during the 1990s till 2012 period, as per DRI.
Again, custom duty on gold bars was increased to 12.5 per cent from 10 per cent in the Union Budget 2019, which became effective from July 6 the same year. In the second half of 2019, while official imports fell, unofficial imports surged 42 per cent, as per the Gold Council Report. A correlation can clearly be drawn between increase in taxation and surge in smuggling of gold in India.
The DRI report suggests that there is an estimated illicit margin of more than Rs 3 lakh per kg of smuggled gold. And the margins increase even further as the price of gold goes past the mark of Rs 50,000 for 10 grams.
A report by IMPACT, a Canada-based non-profit organization, alleges that the ‘Make in India’ initiative that has given policy-based incentives to Indian gold refineries, has encouraged illicit import of both doré (unrefined gold) and refined bullion into India. While doré originates from illicit sources based in South America or Africa, and enters India officially via the UAE and other countries, refined bullion is smuggled into India. The Indian refineries then re-introduce the gold, obtained from dubious sources, into the legal market. The entire illegal network of operations involves Hawala money and illicit gold tied to the human rights abuses in African and South-American countries, the report says.
A Costly Affair
India is the second-largest consumer of gold in the world but does not boast of any significant production, rendering our love for gold a costly affair. As per the World Gold Council report, consumer demand is primarily driven by jewellery, which makes up 77 per cent of the Indian annual demand. And gold jewellery, even while containing impurities that are essential for its manufacture, comes with an added cost of 8-10 per cent, apart from taxes.
The cost involved in importing gold includes transportation, taxes and interests on loans from financial institutions. The imported metal is then smelted and processed further into lumps that can be transformed into consumable goods. Artisans then craft jewellery and accessories that need to be in sync with consumers’ tastes to fetch value in the market.
Speaking with Outlook Money, Somasundaram PR, regional CEO of India at World Gold Council, says “The 8-10 per cent making charges paid on gold jewellery is not actually ‘making charges’ but the extra cost incurred from importing to bringing it into the retail stores in a form that the consumer will buy.”
The other forms in which physical gold is consumed, include coins and bars. These forms, unlike jewellery, do not involve the elaborate costs of smelting, designing and artisans. However, the other cost parameters of import apply.
Is The Passion For Gold Waning?
Demonetisation followed by Covid lockdowns has familiarised all classes of Indians with digital transactions and mobile payments. Government initiatives of doling out subsidies, health insurance etc. through Aadhaar-linked bank accounts has also resulted in more than 80 per cent penetration of bank accounts.
One of the growth suppressants of gold consumption in India is increased financial transparency. With the majority of Indians having a bank account, and increased digital transactions, mattress money has disappeared for a large section of Indians. The dwindling mattress money combined with GST regime and KYC norms for large-scale transactions has provided a push to gold consumption through the grey market.
Somasundaram says consumption of gold in pre-demonetisation years was on an average 743 tonnes annually, which has now decreased to around 550 tonnes. The boost that the grey market for gold got due to demonetisation and GST, reflects in reduced demand in the organized distribution channels.
Increasing urbanization, financial inclusion and financial literacy has, to some extent, changed the perspective of gold jewellery consumers in India. While gold is still viewed as a sound investment, gold jewellery may not be, if the trend continues.
Widening internet and smart phone penetration has increased discretionary spending on electronic goods and apparels, and Indians are saving less than what they used to a decade back.
Moreover, the bankable population in India has crossed over 80 per cent and more Indians are now saving money in banks’ savings accounts than buying gold as an investment option.
According to World Bank Database, India’s saving rate has declined since 2010. Gross domestic saving as a percentage of GDP declined to 27.7 per cent in 2019 from 34.3 per cent in 2010. Declining saving rate challenges gold consumption as the yellow metal is a high-priced item.
In addition to that, rural income and monsoon have an impact on gold consumption as it has long been considered as the preferred form of investment in rural India. As per the data, wage growth in rural India has declined since 2011.
Moreover, decline in rainfall adversely affects rural income as 70 per cent of rural households are dependent on agriculture for their livelihoods.
Access to banking and ease of mobile transactions is also increasing consumers’ affinity to other financial investments that can be done digitally, such as mutual funds and equity purchases through apps. Over 1 million new demat accounts get opened in India every month. Rising equity markets have also propelled urban investors to shift asset allocation from gold to equities.
While the global consumption of gold is for jewellery, investment (as ETFs, coins, bars, medals and LBMA gold), central bank purchases and technology applications, India’s gold demand is primarily for jewellery and investments.
The World Gold Council report states that “financial inclusion and financial literacy, while beneficial for India’s prosperity and income equality, have created challenges for the gold market.” Gold is facing unprecedented competition as an investment asset class due to the changing investment and macroeconomic topography.
***
More Than Meets The Eye
To understand the price movement of gold, we need to understand certain features of the metal as an investment.
Matter Of Yield: Gold is an unproductive and non-yielding asset, while stocks and bonds pay dividends and interest. Therefore, investors must remember that gold investments are relative to the performance of other asset classes. Gold neither pays interest nor dividend, so till the time corporate profitability is expanding and bonds pay positive real rates, investors don’t need gold as an investment.
Year to date, the Nifty index has given over 28 per cent returns, while gold returns are in the negative. However, in Indian rupees, gold has given positive returns since 2000 except for calendar years 2015 and 2013 and till now in 2021 (see table: A Year Of Poor Returns).
Real Interest Rate: The other important feature of gold is how it behaves in relation to real interest rates (nominal interest rates minus inflation). And in this mathematical expression lies the answer to the puzzle of inflation’s correlation with gold prices.
If inflation moves up but nominal rates also move up accordingly, then real rates would remain flat and gold prices would not increase. There is a negative correlation between gold and real interest rates, so negative or lower real rates should move the price of gold higher, and conversely, higher real rates should take gold prices lower.
Between November 2018 and August 2020, gold prices increased by over 70 per cent as long-term US real yields collapsed from 1.2 per cent to (-)1.1 per cent. But after that, there was a rise in real yields as nominal yields (10-year treasury) moved up much faster than inflation, which explains gold’s lacklustre performance in 2021. “But in the past few months, inflation has again started moving up as compared to nominal yields. So, gold prices may move up significantly,” says Ritesh Jain, a Canada-based global macro investor.
Crypto Pull: Interestingly, an important factor that has recently started impacting gold prices is the rise of cryptocurrency. Within 12 years, Bitcoin, the largest cryptocurrency, achieved a market cap of $1 trillion. Some investors are now pouring money into cryptocurrencies rather than gold.
rajiv@outlookindia.com