If gold monetization works, what would be the impact?
By Krishnakumar S.
NEW DELHI: In the light of the growing imports of gold and its impact on the current account of India, Prime Minister Modi has unveiled a plan to tap the treasures in the temples by encouraging them to take to the road of gold monetization. The treasures in the temples of India are estimated to be at around 3,000 metric tons, which is two-thirds of the gold held by the countries in the vaults of the bullion depository at Fort Knox, Kentucky.
Coming as it does from a political dispensation that has the blessings of India’s right, it is unlikely to trigger a political storm in the country. The plan also intends to attract an estimated 17,000 metric tons of gold held in private hands.
Whether the government would be able to attract gold from the sanctum sanctorum of ancient temples is to be seen, given the futile attempts in the past. The previous plans of attracting gold into the banking system failed because the rates of interest offered were too little. If the government is able to attract more gold this time around, with a favorable interest rate, it could meet the growing demand of the jewelry industry in the country.
As per the recent Reserve Bank of India estimates, in the recent past, the net gold imports (that is, gold other than for export purposes) constitute at least 75 percent of the current account balance, accounting for around 2.7 percent of the GDP, a clear leakage from financial savings, which would have been otherwise available for productive purposes.
Indeed from time immemorial, gold has been used as a hedge against inflation and a stable stockpile of value. Over and above, it has served as a buffer against the depreciation of the Indian rupee over the years.
This high preference for gold has kept the interest rates in the domestic economy high, thus effectively proving to be a deterrent to productive investment in the economy. Indeed the Indian demand and desire for this “barbarous relic” was of curious interest to economists like John Maynard Keynes.
Like from time immemorial, India continues to be the largest consumer of gold. Given that its annual domestic production is limited to anywhere from two tonnes to five tonnes, almost all of the demand for gold of 1,000 plus metric tons is met through imports, be it for the jewelry industry, or for other uses.
Even as the annual supply of gold in the world economy is stuck at 3,500 metric tons to 4,000 metric tons in the last 20 years, the demand for gold in India has been heading northwards for long, accounting, according to the estimates of the World Gold Council, for at least one-fourth of the total demand in the world economy. The increases in the price of gold in the world market a couple of years ago have had little impact on the Indian demand for gold. It has been highly price inelastic.
The temples in India, particularly those in the south, are famous for having huge hoards of gold. It was only a few years ago that the revelation of the existence of gold holdings worth roughly $19 billion at the Padmanabhaswamy Temple in Thiruvananthapuram had stunned the world. With the treasures ranging over centuries, from the gold coins of the Roman Empire of 2000 years ago, Venetian gold ducats of the 14th and 15th centuries, Portuguese currency during its times of glory in the 16th century, 17th century coins of Dutch East India company, and Napoleon’s gold coins from early 19th century, it was clearly reflective of the primacy enjoyed by India as maritime trading power in the pre-industrial revolution period.
In return of the export of spices, muslin, calicoes and textiles to the west, India imported nothing but bullion in return, proving Pliny’s concern that that India would drain Rome of all its gold, true for all of Europe, and the whole of the world. India was literally turning out to be sink of gold. A good part of that gold and silver which made its entry into Europe in the course of the 16th century price revolution following the Spanish conquest of the Americas, made its entry to the coffers of the East.
History apart, would the policy have an impact on the infectious Indian appetite for gold? Would it have a favorable impact on the current account balance?
In the pure accounting sense, in case a part of the demand for gold is met through the supply coming from the monetization of gold, the imports of gold would decline and the current account would improve. But this could further result in the appreciation of the real effective exchange rate, thus eroding the competitiveness of other commodities in the international market. So, on the one hand, while the reduction in gold imports would reduce deficit, it could get widened by loss of competiveness of other commodities. So, at least when the real exchange rate is not competitive to begin with, this plan would not yield the intended outcome.
Moreover, given that India is the largest consumer in the market for gold, the induced reduction in the demand for gold in the world economy from India could result in the price of gold in the international market declining.
Given that even when the price of gold in the international market were high and rising, the demand for India was only moving northward, would it be appropriate to expect that the demand for gold would falter if the price goes down? Indeed, if there are no strong tendencies of destabilizing speculation, the quantity of gold imported with international price decline would increase, thus enhancing India’s import bill.
This good intent behind the gold monetization plan apart, it is to be seen whether the palliatives prescribed by the doctors at the Finance Ministry and the Reserve Bank be able to address the infectious Indian demand for gold from time immemorial?
Krishnakumar S. teaches economics at Sri Venkateswara College, University of Delhi