A solution to Indias obsession with gold

Written by Soumya Kanti Ghosh | Updated: Sep 16 2013, 10:35am hrs
Indias obsession with gold is nothing new. It may be noted that India had a gold control policy since Independence that was abolished in 1990, following the BoP crisis. Policymakers in India have tried several options in the past, like issue of gold bonds, voluntary disclosure scheme, considered having a gold bank and have also tried a gold deposit (GD) scheme, all of which met with limited success. Recently, there were reports in the media suggesting that the government is planning a GD plan whereby commercial banks will buy gold from ordinary citizens, divert it to metal refiners to curb gold imports, and thereby put a check on Indias burgeoning CAD. In fact, this has now been suggested even by the PMEAC. While such a scheme was tried in 1999 but did not succeed, we hereby offer a plana vanilla suggestion of GD, but with some crucial distinctions from the earlier ones. This, we believe, may be a much better way of managing the countrys obsession with gold and provide a breathing space for now.

Gold has always been in the news, even internationally. The US, before 1933, had an exchange rate mechanism, defined as Gold Standard, where the dollar was defined in terms of gold. After the abandonment of the Gold Standard, the world moved to Bretton Woods, a quasi-Gold Standard exchange rate mechanism, whereby gold transactions were limited to official settlements with other countries central banks. The world formally moved out of such a system in 1974, with the dollar being globally recognised as the principal medium of transaction. However, post 2000, following a commodity market boom, the yellow metal is back with a vengeance. Additionally, countries like China have been aggressively diversifying their cash reserve position away from dollar-denominated instruments (between 2004 and 2009, China doubled its official holdings of gold by 500 metric tonnes). India also augmented its gold reserves by purchasing $6.7 billion of IMF gold in November 2009, possibly as a strategy of asset diversification.

Coming back to our GD scheme, we have listed the salient features of our GD scheme in table 1 and offered a juxtaposition of our proposed scheme with the 1999 one. Let us make it clear that what we are suggesting is not a gold buy-back scheme but a pure GD scheme.

Given the juxtaposition, we also estimated the potential benefits to the economy because of a such scheme. For this, we assumed, as per the World Gold Council estimates, that 75% is in jewellery, 23% is in bars and the rest 2% in industrial use. Table 2 shows the total dollar value of gold mobilised may be significantly high, even if we assume that only 10-30% of the gold bars is mobilised. The upside to such deposit mobilisation may be even higher, with a 50% strike rate allowing us to cover our entire short-term debt with residual maturity at $170 billion.

The GD scheme should not be looked at from the myopic lens of addressing only the CAD. Drawing inspiration from China, tapping such vast gold reserves will also strengthen the case for rupee as an international currency in the years to come. This should be an objective from a long-term strategic interest, given that India is exploring trade swap agreements currently. Some people are advocating that a KYC norm for gold purchase be made compulsory as a solution. We believe such a norm would only encourage purchase through unofficial channels!

The author is chief economic advisor, SBI. He thanks Saket Hishikar for research. Views are personal