Thirst for Gold Robs India Economy

It is easy to find the roots of India's economic malaise in government indecision, entangled legal processes, wasteful and often hypocritical subsidies supposed to help the poor. It is easy too to blame democracy and de-centralization for government paralysis and on corruption which - unlike in China - often fails to delivers results.

But from the point of view of foreign observers, these are just additional problems added to a much more fundamental one. Perhaps it is best illustrated by a statistic released this week and which put further downward pressure on the rupee. India's current account deficit for the June quarter widened further to US$21.9 billion or 4.9 percent of GDP.

But no less than US$16.5 billion of this was accounted for by imports of gold. In other words, without the import of the almost useless yellow metal, the nation's current account would have been little more than 1 percent of GDP, a figure of little consequence. Although gold imports fluctuate widely from quarter to quarter, on average India is buying around 1,000 tonnes a year worth around US$50 billion - plus whatever is smuggled from Dubai and other Gulf centers. Thus investment in gold amounts to roughly 3.5 percent of India's GDP.

In late August, a source told Reuters that the Reserve Bank of India, the country's central bank, would launch a pilot project to ask banks to buy back gold jewelry, bars and coins for rupees. Lenders would have to offer better rates than pawn shops and jewelers to lure sellers. The government has already raised import duties three times in the past year on gold.

While gold is considered auspicious as a gift or offering at religious festivals, and forms an essential part of a bridge's dowry, families amass it as both fashion accessories and as a cultural objective - as well as a hedge against economic disaster. In addition, according to Reuters, India's Tirupati temple, considered one of the world's richest, is estimated to hold gold worth up to $80 billion.

Imagine too if that US$50 billion had been invested in public health, education and basic infrastructure what that could have done to improve living conditions in the medium term, to enable manufacturing to grow fast, for jobs to be created from the vast pool of underemployed rural and urban informal workers.

Gold imports may not stay quite this high either because of increased import duties and the rising rupee cost of gold in devalued rupees. But nonetheless it is evidence of a pre-modern mentality which runs throughout much of Indian society, from top to bottom though more obviously in the northern than the southern states.

It is nonsense to claim that the pursuit of gold is a natural response to currency and inflation uncertainties. India has a history of continuous but moderate inflation, never of the bouts of hyper-inflation seen in many other countries from Brazil to China. At the same time, interest rates in India have mostly been in positive territory, albeit by a narrow margin, so that savings have not been continuously eroded by inflation while gold has provided a good hedge. Indeed, gold prices have been and will likely remain more volatile than the rupee and return nothing.

The gold obsession clearly indicates that basic capitalist instincts are honored in theory but little practiced in a nation where big money is made by trading - or dubious deals with officials - than by investing in production with an expectation of a return of 10 percent or more. Meanwhile middle and lower income groups find few outlets for their savings other than gold either because financial mechanisms are undeveloped or the opportunities for investment in small and family businesses are limited by other factors.

For sure India is not alone in its gold obsession. Vietnam is too. But in Vietnam gold plays a part in the formal financial system and thus enables gold wealth to be put to use through gold-backed loans to family businesses.

Again unlike Vietnam, the Indian obsession seems more closely linked to the feudal attitudes which have given low priority in most of the country (some states honorably excepted) to education, leaving it with literacy rates lower than most of Africa and the whole of east Asia.

Increasing taxes on gold imports is no solution. It would lead to more smuggling and if anything make gold acquisition seem even more desirable rather than the huge obstacle it currently presents to India's hopes of sustained growth in incomes and quality of life. Alternatively a complete ban on imports could knock the gold price so badly as to undermine confidence in its value. Without that 1,000 tonnes of Indian demand, no less than 35 percent of global production, the price would surely collapse. It would even be hard to prevent it falling to or below US$700, roughly the average cash cost of producing mines.

Maybe the best that can be hoped for in the medium term is that the gold price falls without inducing a rise in Indian buying. But ultimately it needs a change in Indian mentality if this waste of scarce resources is to end. Gold is a cause as well as symptom of India's still backward condition.