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All That Glitters Isn’t Gold

 3 min read / 

Indians love gold. The nation has just regained its position as the largest consumer of the commodity according to the World Gold Council. There are multiple reasons for this. India has been a republic for only 55 years and trust in the government and institutions has always been low in South Asia. Gold acted as an easy means to hide wealth from those in power, buffer against falls in currency and insurance in case of catastrophe. Secondly, gold worn by a bride during her wedding are seen as a dowry payment to the groom. This is why India’s gold demand peaks during the winter months when weddings are most frequent.

The problem for the Indian government and the economy is that gold is an unproductive asset. In macroeconomic terms it causes all sorts of headaches in widening the countries current account deficit (CAD). Oil and gold are two major commodities, which form part of the Indian import basket. India’s CAD rose in the September quarter on the back of gold imports despite Brent Crude falling to $60 dollars to the barrel. This unexpected rise in CAD has knock on effects for the currency at a time when emerging market currencies are staring at declines against a strong US dollar. India’s Central Bank has shied away from a rate cut to protect the Rupee despite inflation falling drastically. At the heart of its decision is uncertainty over the role of gold in widening the CAD. This will effectively curtail economic growth.

High gold and oil prices coupled with weak exports and the Indian economy is staring at a perfect storm. This is exactly what happened in the later half of 2013. It is a fundamental structural weakness which needs to be remedied at a time when there is some room to manoeuvre due to falling commodity prices. The long-term solution is obvious. While global oil and gold prices are out of its control, India can step up reforms and diplomacy to boost and diversify its exports. Currently the premier export region for Indian goods is the European Union, which is facing recession. Africa and Latin America must be seen as priority markets. Exports to these regions must be supported via diplomacy and free trade agreements.

In the short term the Indian government has made attempts to curb the flow of gold by slapping taxes on importers. This approach, as argued before, is counter productive. A more substantial and bold solution, argued in some quarters, calls for setting up of a national bourse or exchange for a series of gold backed financial products. It would help put gold to better use and monetise the commodity rather than it sitting idle in vaults inside banks. It has the potential to create thousands of jobs in designing, trading and marketing such products. If successful it will boost internal growth and make India more resilient in the face of global economic downturns.

 

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