Is Gold the real Villain of Economy?

The rising fiscal deficit in India is a matter of concern for the country but for the government of India it  is the Gold which is portrayed as the Villain and a prime reason for such rising deficit. However gold is not a villain as portrayed by the government, on the other hand it is the people’s mentality on the rising tax; since there is a low public acceptance of the fact that the state should tax the people.

Budget 2013-14 Highlights

During the budget 2013-14, the finance minister clearly stated that the passion for gold by individuals has resulted in high current account deficit. He said there is a desire of possessing gold by the Indians, which results in huge buy side demand and as a result of which India faces huge import of gold leading to high CAD. Finance minister unveiled the proposal of introducing inflation based index bonds, which will act as a hedge instrument for the investors, apart from gold and will thus help in keeping a check on gold consumption.

Statistics about Gold Import

Arithmetically if we remove the $60 billion from the annual import spending, which we the world’s largest bullion importer pay; we would see a drastic reduction in overseas capital that India needs to cover its current account shortfall. Also the move will result in an upward pressure on the rupee which will invite foreign capital in future.

The move will help India join the credit-fuelled investment boom. There has been an attack on gold in the past with government slapping higher import duty on the metal two years in a row, but an expected solution still remained a distant dream. Increasing duty further will lead to smuggling of the metal which again is an undesirable situation for the economy.

Read more about Gold ETF Funds in India.

Statistically it is seen that our current account deficit is valued somewhere around 5% of GDP. If we talk about the sustainable acceptable rate which does not raise risk of currency, we find it to be somewhere half the current level. If we were to implement the capital account convertibility in future, we need to ensure that the deficit is well within acceptable limit. Lowering the deficit requires changes in savings and investment patterns not only for the households but for the companies and the government as well.

General Trend about Gold

It is seen as a general tendency of every household to improve their balance sheet by acquiring financial assets supplied by the corporate sector, state and rest of the world. Investment using rest of world requires foreign exchange which has to be earned by exporting goods and services. If we compare India’s population with Indian market, we find over 17% of the world’s population to reside in our country but the existence of market is nil when it comes to industrial base. Also we do not have a proper industry development to sell products/services in the rest of the world (83%) and only deal in computer software which is robust and outsourced.

Problem

The problem leads to a current account deficit, as the household depends only on domestic sources to accumulate wealth and invest in instruments like local corporate bonds and equity.
If we talk of banks, an important source for channeling savings to investments we find a RBI norm regulating the banks which requires a minimum of 23% of deposits in government securities. The method of government issuing bonds to meet the household demand for wealth is probably a wrong measure as in India; the sovereign currently is yet unable to firmly establish its right to tax incomes.

Recommendation

The government needs to solve the problem currently which could be done by a phased manner increase in the tax-to-GDP ratio from current 10% to over 25% by 2020-25 as prevailing in several countries like Mexico, Australia, Japan, United States, etc.

Strategy for raising tax will allow government to stop forcing banks to invest in debt securities. At that point securities like government bonds will be willingly bought which will result in demand for gold to wane.
Thus government currently need to improve on tax not by raising the tax rate but by widening the horizon of tax.

Read on GWI The Indian Gold Habit – Reason, Problem & Solution.

Public investment in rural India especially in irrigation, health and education will boost productivity in long run and will bring down the rate of inflation which will dim the allure of gold as an investment vehicle.