Given India’s $25.7 billion gold imports in Jan-Sept 2014, it is understandable the government wants to crack down on imports. This would be a mistake. For one, since gold imports were $42.7 billion in all of 2013, there has been a lot of compression this year. Two, import curbs will incentivise smuggling. Indeed, when India was hiking import duties, from 4% in February 2012 to 6% in January 2013 and 8% in June 2013, demand rose from 202 tonnes in Q1 2012 to 256.5 tonnes in Q1 2013 to 310 tonnes in Q2 2013—rising global prices raised returns on gold and gave demand a fillip; with gold prices falling in 2014, demand is much lower. It is equally important to look at the composition of imports. Investment demand, or demand for bars and coins, is down from 64 tonnes in Q1 2012—when, due to considerable global uncertainty, prices were soaring—to a more manageable 42 tonnes in Q3 2014. What made gold demand soar in Q3—it rose fourfold yoy in October, to $4.2 billion—was jewellery demand rising to 182.9 tonnes, from 154.5 tonnes in Q2 2014. In other words, as gold prices have fallen, repressed consumption demand is returning.
While the government may want households to switch gold to financial products—financial savings are down from 12% of GDP in FY10 to 7.1% in FY13—households have few other investment avenues. Whether the Kisan Vikas Patras (KVP) reintroduced yesterday will help is not clear, the lack of KYC in gold purchases is a factor in their favour—the KVPs, in contrast, have KYCs. Also, household gold purchases were only around 2.5% of GDP in FY13 while real estate accounted for around 12.2% of GDP—with physical savings steady at around 13-15% of GDP for the past few years, this means households are not switching from financial savings to physical ones, they are just not finding lucrative financial savings options.
In this context, dematting of gold is a good idea. An investor looking to protect R1 lakh of savings will buy a paper promising to give her 38.2 grams of gold at today’s prices; the bank selling the paper will not buy gold, but will buy a call option for 38.2 grams of gold in global markets—as and when the investor wants out, the value will be redeemed based on the current gold prices; there is minimal forex outgo since only a call option is being bought. Of course, since the call option will cost money, typically 4-5% a year, investors will have to bear this cost. Since no investor will want to bear this cost—she will simply invest in physical gold—the government will probably need to think of a subvention scheme, with appropriate safeguards, since it saves on valuable foreign exchange according to AV Birla Group chief economist Ajit Ranade. Others have different schemes, but the short point is alternative savings instruments are needed before households are forced out of gold.