How do gold investments affect the Indian economy?

How do gold investments affect the Indian economy?

Culture, customs, and traditions have a higher priority in India over anything. Investment in gold is one of those traditional practices. Gold is considered a symbol of wealth and purity rather than investment.

We, Indians, are one of the largest consumers of gold in the world. India consumes almost 1/3rd of the global gold on an annual basis. But what will happen with the gold we buy every year? It gets accumulated in bank lockers. It has no alternative use other than wearing it as an ornament and having a liquid instrument to arrange cash in times of necessity. There is no industrial application. Investment in gold is referred to as “dead investment.”

Dead investment refers to an instrument that will not revolve or rotate or get exchanged to grow itself. Usually, when you invest in a stock, you expect volatility and expect returns from the investment. This does not happen with gold.

Impact on economy

We can observe a voluminous buying of gold during the festive and marriage season. Now imagine every other person in India investing at least 20% of their annual savings in gold and holding it for a long term (say 5 to 10 years). This strategy is known as the “buy and hold” strategy. As per this strategy, the prices of commodities (gold in our case) will move up due to an increase in demand. To satisfy the unending hunger for gold, the government has to import gold from abroad. It puts pressure on the government reserves and leads to a Current Account Deficit (CAD). Current account deficit means spending more than earning, and it is risky for any economy.

India imports around 800-900 tons of gold every year. As per the Ministry of Commerce, gold imports have increased by a whopping 22.58% (amounting to $ 34.60 billion) in the Covid-affected financial year 2020-2021 (Business Standard, April 18, 2021). Even if the import duty on gold was 12.5% before budget 2021, people still have that instinct to purchase gold on every possible occasion.

Now there are serious implications of a current account deficit, some of which are:

  1. The deficit amount has to be financed through foreign borrowings. This leads to piling up of interest liabilities year-on-year on such borrowings.
  2. Chances of reduction in foreign direct investment due to loss of confidence of foreign investors. This leads to a devaluation of the domestic currency.
  3. Current account deficit implies a surplus in the capital account. This means the foreign ownership of domestic assets will increase, and Indian would be dependent on infrastructure financed by foreign entities.
  4. Current Account deficit is linked to an unbalanced economy.

Every point above affects the daily life of an Indian citizen.

Still, want to invest in gold?

If you still wish to invest in gold, why not invest in exchange-traded funds of gold rather than buying and holding it? This gives more volatility to the gold prices. The Gold Monetization Scheme 2015 was launched by Prime Minister Narendra Modi to transport the gold reserves held by the Indian public in bank lockers to government custody. Investors get certificates for gold investment, and the government can utilize the gold reserves to turn it into a productive device. Investors can redeem their investment in the form of gold or money at the rates prevailing on the date of redemption. This would eventually help the country reduce dependency on physical gold and trade on gold as a derivative instrument.

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Josephine