Gold may be the new Swiss bank: $1 mn of black money = 25 kg of gold

The government is said to be mulling curbs on imports of gold after witnessing two consecutive months of surge in September and October. According to a report in _The Economic Time_s, gold imports may have soared nearly six-fold in October to 148 tonnes (over last year’s artificially low levels), coming on top of 39 percent growth in September.

Since high gold imports have an impact on the current account deficit (CAD) and the rupee’s value against the dollar, alarm bells are ringing both in North Block and Mint Street.

Noise from these bells may be ear-splitting, but Arun Jaitley and Raghuram Rajan should put on earplugs and work on the root causes of the gold import surge. Panic action will do more harm than good. They are reportedly thinking of further clamps on gold, even though import duties are already prohibitive , having been raised five-fold from 2 percent to 10 percent in August last year. The World Gold Council estimates that 200 tonnes of gold may be smuggled into India this year, nearly a quarter of total annual demand.

The central bank and the finance ministry will also have to reckon with a new threat: the possibility that incremental black money generated in India may be moving towards gold once more. With Swiss bank accounts under siege, keeping a million dollars in gold is both safer and easier. A million dollar is 25 kg of gold. Not a large physical size for storage in a bank locker for anyone.

Here’s a dumbo’s guide to what may be happening in gold.

First, and most obvious, Indians have had a centuries-old appetite for gold that has very low linkages with price. Indians buy gold both for use value (jewellery) and store value - that is, as a long-term hedge against inflation. Over the very long term only gold has retained its value.

Second, it follows that gold is a form of saving in India, not speculation. This is why people buy some gold whatever its price. They buy less when the price is high, and more when its price is low. It’s like what mutual fund investors do with systematic investment plans (SIPs). Gold buyers are smart SIP-pers. They buy regularly and build a portfolio. Right now global gold prices are down over a third from their all-time peaks three years ago - which means more gold can be bought for the same investment.

Third, the import spike this year is a natural reaction to excessive curbs last year. If you artificially compress supply by physical and financial means, demand will jump at you like a jack-in-the-box the moment curbs are eased or unmet demand builds up again over time. Both things have happened. In May, curbs (but not duties) on gold imports were reduced, and in September-October this year people bought gold that they could not buy in last year’s festival season.

Fourth, black money may be chasing gold now. Ever since the issue of unmasking the holders of Swiss bank accounts became a political obsession in India, the fresh black money being generated in Indian transactions that would normally have gone abroad to Switzerland, the Cayman Islands or Mauritius is staying in India for reasons of safety. This money has gone partly into gold and real estate. All holders of black wealth abroad know that tax-havens are under global attack and sooner or later they could face a crackdown, with people holding money there facing criminal charges. This is one reason why even the names already given to India by the French government have zero-balance accounts. The money has largely flown.

Consider what you would do if you had a million illegal dollars stashed abroad and you know the government is going to get after it, one way or the other. You will try to either move it to a safer place (increasingly difficult), or bring it home where you can guard it personally.

A million dollars of black money would amount to around 24-25 kg of gold bars at current global prices of $1,555-1,560 an ounce. Storing a million dollars is easier in gold and real estate than in a Swiss bank account that can be traced back to you. Gold gives you value preservation and anonymity as the metal always has a market in India. Gold would, however, work for medium-size black money holders generating upto $1 million annually; for much larger amounts, real estate may be a better bet.

As I have said before, gold is the aam aadmi’s Swiss bank account - a saving that retains its value over generations and can be passed on to progeny. The additional factor this time may be that even the khas crook may have piled into gold to anonymise his black money.

Can, or should, the government do anything to deal with the gold craze?

Yes, but the remedies are long-term.

#1: For the aam aurat, make savings inflation-proof. I believe an easy instrument like the fixed deposit, which is actually more popular than gold, if it is given a measure of inflation-proofing, will take off vertically and challenge the lust for gold. Over time people will see value in this, but this also calls for a long-term government commitment - both fiscal and monetary - to keep inflation down. Only this will keep the costs of such inflation-proofing down for the government.

#2: A formal black money amnesty scheme is overdue. It will take some of the immediate pressure off gold imports and give the government cheap resources for investment in growth and building infrastructure.

#3: Moderate taxes, minimal restrictions on external and internal gold trade, and transparency in government rules and state funding of elections will reduce the long-term demand for black money. If accompanied by no-nonsense implementation of tough, new laws on tax evasion and money laundering will force a gradual reduction in the attraction of black money.

#4: Gold hoarders (excluding those who hold it for black money storage) are actually behaving more responsibly than the RBI. Gold purchases amount to savings; in contrast, the RBI’s scheme last year to encourage NRI deposits at low cost amounts to encouraging borrowing. If saving is better than borrowing, why should gold buying be considered a criminal activity and not the RBI’s reckless dollar borrowings abroad?

So, Dr Rajan, Mr Jaitley, cool it. Think the issues through before plunging mindlessly into further gold import curbs. You will only help smugglers.