Article

India’s Gold Bug

Pramit Pal Chaudhuri March 8, 2013

There’s been a lot of commentary on the huge surge in Indian gold imports and the damage it is doing to the current account deficit, with much weighing of the pros and cons of the government’s feeble attempts to stem the yellow tide.

India is the world’s largest gold importer. The estimated value of individual holdings alone is some $1 trillion dollars — equal to 70% of India’s present GDP. Indians have been putting more money into gold than they have into life insurance premiums, mutual funds and almost any type of savings other than bank deposits — which have been shrinking in a not unrelated phenomenon.

Why are Indians buying so much gold? The standard (and sensible) argument is that Indians are seeking an inflation hedge. With inflation in double digits and the real interest rates being offered by any type of bank account basically zero or negative, gold is sensible hedge. The Reserve Bank of India is among those who have weighed in and warned that until inflation moderates (and the government reins in its red ink ways), such gold buying will be difficult to stop.

But the inflation argument does not hold up too well against the data. Gold buys in India took off in 2009, jumping from about 500 tonnes to just over 1,000 tonnes by the middle of 2011. But the consumer price index had reached 11% in India by the end of 2008, a position it largely held until 2011. The real game-changer for gold imports was the 2008 global financial crisis. The combination of the crisis and, secondarily, inflation was the main trigger for the shift to gold.

Though hard to calculate, the evidence is that the proportion of Indian purchases of gold for investment purposes relative to personal consumption (weddings, gifts, jewelry for adornment) remained the same throughout. This brings me to the second reason for the rise in gold buys: rural prosperity.

Whatever else you can say about the Manmohan Singh government’s welfare schemes, they pushed a lot of money into rural India and boosted rural incomes, especially for land-owning kulaks (like the wheat farmers in Punjab, Haryana and western Uttar Pradesh). And it is exactly this group that is most addicted to gold, that massively increased their gold purchases.

A Morgan Stanley Alpha wise study on Indian gold buying habits supports this. The study listed 35% of those surveyed as buying gold for life events, like marriages. This was the most rapidly rising category, and the study’s authors expected this reason to account for 50% of gold purchases by 2020 — even as buying for investment purposes would remain at about 20%. Indians like to buy gold for these sort of reasons as they get wealthier. The dip seen in gold imports in 2012 is attributed to the poor monsoon that affected the buying power of Indian farmers.

While taming inflation will help, the best way to wean Indians off their present overzealous gold buying is to revive the economy as a whole. And encourage rural people to move to the cities. All this will take time, so the gold bug biting India will continue for some years to come.