View: Can we not 'go for the gold' just this one year?

What happens when a country produces less but consumes more of something? The country ends up importing it. And if the imported item keeps getting more expensive, the country ends up paying more and more to import it. Not a desirable situation for any country to be in, but this is exactly the situation India is in today, as imports in June 2022 peaked up to $63.6 billion.

With commodity prices already on fire due to the war in Ukraine, India’s import bills for coal, petroleum and fertilizers have jumped. This is leading the country into a trade deficit and a weakening rupee, which in turn stoke inflation.

At such times, an increase in gold imports is certainly not what India wants. The World Gold Council reports that India's gold imports reached their highest level in ten years in 2021. The continuing surge in gold imports is putting pressure on the Current Account Deficit (CAD). As the trade imbalance widened to $189.5 billion in FY 22 from $102.2 billion a year ago, India's current account balance showed a deficit of 1.2% of GDP in FY22 against a surplus of 0.9% in FY21. Unless we take some radical steps to stop the expanding CAD, we should be prepared to see it rise further in FY23.

Through a notification issued on 1^st July 2022, the Government of India increased the effective import duty on gold from 10.75% to 15%. Of course, that is not the only thing that the government has done to support the falling rupee and control the runaway imports to check trade deficit. It has also imposed taxes on the exports of petrol and diesel. But as the world's second-biggest consumer of the precious metal, India must make all efforts to restrain the demand for gold. While the government has increased import charges on gold in the past also, India’s demand for the yellow metal has remained fairly inelastic.

Investing in gold is integrated into the Hindu tradition, and strict followers of the customs invest in gold with consistency at least twice a year. This tradition of investing in gold is the equivalent of a Systematic Investment Plan (SIP) for gold. Strict followers of the tradition invest in gold with consistency at least twice a year, once on the occasion of Akshaya Tritiya, which falls in the latter half of April or the first half of May each year, and then again on the occasion of Dhanteras, which is typically in the second half of October or the first half of November each year. Even the sharp rise in gold prices have over the last decade have not stifled the household demand for gold.

For Indian households, perhaps, gold does not have any straightforward investment substitute. The traditional role of gold in Indian marriages remains intact. However, with the well-regulated and accessible financial markets, and the rising interest rates, Indian households must reexamine the attractiveness of physical gold as an investment. The rationale for investing in gold as a safe investment, a hedge against inflation and a portfolio diversifier is undeniably strong. Yet, while there may be no substitutes for investing in gold, there are alternatives.

Indian households can adopt alternate ways to invest in gold, and contribute to reducing their country’s demand for gold by reducing demand at the household level. Not many can be a Neeraj Chopra and earn gold for their country, but so many can keep their names off the list of gold buyers. The alternatives come as financial products linked to physical gold, and there are enough reasons for investors to pick these financial products over physical gold. Firstly, holding physical gold comes with the hassle of safe storage. Gold must be kept in safe lockers, and this adds to the cost of holding it. Secondly, there are quality issues with physical gold. Often, the gold ornaments that households buy are low in purity, and buyers can even lose the entire investment in gold due to its bad quality. Thirdly, when these ornaments are sold, there is a steep discount of 10-20% levied by the buyer, who is invariably a jeweler. This reduces large part of the gains in the value of gold. And finally, the process of buying and selling physical gold is mostly cumbersome, though may be enjoyable for some, but the process does add to the imperceptible costs of investing in physical gold. Therefore, investing in physical gold is no longer the most optimal way of taking advantage of this asset as a portfolio diversifier.

As the financial markets in India have matured, investors have been offered diverse solutions for investing in financial products backed by physical gold, which are linked to the gold price. These are safe, simple and attractive financial products that allow the investors to hold a part of their portfolio in gold, while doing away with the complications of holding physical gold.

The increased direct participation of retails investors in the financial markets as witnessed in the large number of dematerialized trading accounts that were set up in 2021, and the huge subscriptions that were received by IPOs, some even of not-yet profitable companies, is a sign of changing times. Factors such as an increase in smartphone usage, the rise of discount brokers such as Zerodha and Upstox, easier digital onboarding of investors, and of course, attractive returns delivered by the equity markets are symptomatic of a change in investor attitudes. The number of active trading accounts in the country has jumped 63 per cent in the past 12 months to almost 90 million in FY22.

This is the time to help Indian investors take their next step. The best way to save some money in these times of inflation is to stop buying expensive gold. Even without a hike in import duties, which some argue encourage gold smuggling, the demand for gold imports can come down if only Indians can stop buying gold, for just one year. Or if they must buy gold, there are some well-established gold-based financial products available in India. Mass awareness and acceptance of such financial solutions can help curb the gold import demand significantly, and thereby reduce the strain on country׳s CAD to a great extent.

Two useful alternatives are the Gold Exchange Traded Funds (ETFs) and the Sovereign Gold Bonds (SGBs). Gold ETFs are like Mutual Fund units representing physical gold in dematerialized form. They are passive investment instruments, and are a great investment choice for portfolio diversification with the safe haven gold investment. For investors looking to invest in gold, Gold ETFs do just that – they invest in gold and track the domestic physical gold price. One Gold ETF unit is equal to 1 gram of gold and is backed by physical gold of 99.5% purity. Additionally, they are regulated by SEBI, and are listed on both NSE and BSE. Gold ETFs combine the flexibility of stock investment and the simplicity of gold investments. The minimum investment amount in Gold ETF is equivalent to the current price of 1 gram of gold. ETFs are suited for investors who may want to convert their ETF holdings to physical gold later.

SGBs, another alternative to holding physical gold, are government securities denominated in grams of gold. They are issued by Reserve Bank on behalf of Government of India. Investors can buy the SGBs at their issue price, enjoy interest and capital appreciation, and the bonds are redeemed on maturity. Investing in SGBs is a better alternative than physical gold, as the risks and costs associated with holding physical gold are eliminated. SGBs also are a better investment choice than physical gold. Firstly, these gold bonds, when purchased online, come at a lower price than physical gold. Secondly, investors get a fixed interest rate on these gold bonds. Thirdly, gold bonds have no holding or storage cost.

Another way Indian households can contribute to reducing their country’s demand for gold is by recycling it. China holds the top position as a gold recycler, followed by Italy and USA, and India is at the fourth position. As per the World Gold Council, over the past five years, 11% of India’s gold supply has come from ‘old gold’. Even though India, in 2021, recycled 75 tons, or 6.5 per cent of the total gold recycled across the globe, the country’s gold recycling industry is largely unorganized. Yet, if for just one year, Indians resolve not to buy new gold, but opt for either investing in the financial products linked to gold, or for recycling their gold, India’s CAD challenge will find a golden solution.

The writer is Professor (Finance) at the Indian Institute of Foreign Trade, New Delhi.