Gold rush, again

India’s gold imports in terms of quantity in the first half of 2017 crossed the entire imports of 2016. The country imported 510 tonnes of gold in 2016, while the imports in January-June 2017 were 521 tonnes. Imports could cross 900 tonnes this year against an average of 709 tonnes in the past five years, according to data compiled by GFMS Thomson Reuters. The import bill is expected to cross $40 billion this year, which will be the highest in value terms since 2012. There could be many reasons for this renewed focus on a traditional asset. Demonetisation made households wary about holding cash stashes and also temporarily suppressed gold demand. Also, low global prices have made gold look more tempting. The jewellery industry, too, stocked up ahead of the goods and services tax regime that kicked in on July 1.  Speculation that the new tariff might be as much as 5 per cent for bullion traded locally, including for manufacturers buying from importers, had prompted a jump in imports to 126 tonnes in May. But much to the trade’s relief, the gold rate was eventually set at 3 per cent.

Enhanced gold purchases point to an underlying sentiment. Gold hoarding is usually associated with fears of economic chaos, currency weakness or inflation. While none of this is anywhere on the horizon, fears of further government action against black money could have persuaded investors to convert illicit cash into gold prior to the imposition of the GST with its multiple checks and controls. It has also triggered a switch away from gold exchange traded funds (ETFs), which can be tracked easily. Another reason for the preference for the physical asset could simply be the lack of viable alternatives for a conservative investor. The real estate market is subdued partly due to the impact of demonetisation. At the same time, the stock market is at an all-time high, making valuations unattractive for long-term investors. Indeed, households parked a substantial chunk of their 2016 savings in mutual funds and may now be looking to diversify away from high-risk assets.

But there are at least two reasons why a preference for gold is bad news for the macroeconomy. One is that gold is an asset that cannot be easily put to work to finance business expansion and generate returns. This implies that a huge amount of money could be stuck in an effectively unproductive asset. A large chunk of that money consists of savings  which should, ideally, have been deployed in financing entrepreneurial activity. This is also a symptom of the slow investment cycle — credit demand is down and private enterprise is wary of committing to capacity expansions. The second issue is that these are imports which directly and adversely affect the trade balance. In fact, gold is the second largest item on the import list. The government has no option but to take confidence-restoring measures to persuade households to switch savings away from such an unproductive asset. But that could take a while. The GST will need to settle down and associated fears about an inspector raj will have to be allayed. Most importantly, the private investment cycle needs to revive.  If private enterprise sees avenues for higher returns, the asset mix will automatically move away from gold and back to financial assets.