CIRCUIT BREAKER. For savers, gold is losing its glitter

It’s the proverbial seven-year itch. After seven long years, the love affair that Indian households have had going with bullion is cooling off. Or at least, that’s what recent data points suggest.

For starters, there’s the moderation in India’s gold import bill. In April to June 2015, at $7.5 billion, India’s bullion imports increased just 7 per cent over the same period last year, far lower than the 20 per cent increase seen in 2014-15.

If gold imports continue at the current run rate, the country would spend just $30 billion on bullion purchases this fiscal. Not only would that be lower than last year’s $34 billion, it would also be a good 40 per cent saving over the $53-56 billion that we expended in the crisis years between 2011 and 2013.

Though part of the savings in the import bill can be attributed to lower prices, it is certainly a surprise that falling gold prices haven’t yet triggered a gold buying binge. In the past, Indian jewellery buyers have thronged to the showrooms on any signs of gold price weakness. But not this time around. The jewellery trade built up substantial inventories ahead of the festival of Akshaya Tritiya (late April), but has registered tepid sales and now appears to be saddled with excess inventory.

If physical buying of gold has moderated in recent months, paper gold has been out of favour for a while now. Trends in fund flows into gold exchange traded funds show that investors have redeemed units worth ₹4,000 crore since April 2013, after making massive new investments of over ₹6,000 crore between 2012 and 2013.

This sudden disenchantment of Indian savers with gold must certainly come as a surprise to policymakers, because it has come about with very little effort on their part. When the country’s bullion import bill was galloping without check in 2011-13, apart from issuing fervent pleas to the public not to buy gold, policymakers put in place several draconian measures to curb gold buying.

The import duty on bullion was hiked from 2 to 10 per cent. Banks were barred from distributing gold coins and bars, or selling gold on a consignment basis to jewellers. The RBI came up with the convoluted 80:20 rule, requiring banks to ‘verify’ that, for every kilogram of gold imported into the country, 200 grams was shipped out as exports. Restrictions such as the 80:20 rule and consignment sales of gold to jewellers have been relaxed in the last 12 months, after the collapse in global oil prices has made the current account deficit a non-issue.

Ironically, Indian savers, who ardently pursued bullion when the Government didn’t want them to, are turning away from the asset after those curbs have been relaxed!

But why are domestic savers suddenly disenchanted with gold? While one may believe that it is best not to look a gift horse in the mouth, understanding the reasons for the recent weakness in gold demand may help the economy make the most of this bonanza.

Experience suggests that three key factors could be behind the recent cutbacks in domestic bullion purchases.

For one, there’s moderating inflation. The world over, one of the key reasons why savers buy gold is that they see it offering a better store of value than paper money.

One may think that Indian savers are not so sophisticated, but based on data, a clear link can be drawn between the domestic gold buying binge and rising inflation rates. It is certainly no coincidence that India’s annual bullion import bill shot up from $14 billion to $20 billion between 2006-07 and 2008-09, precisely the period when consumer price inflation accelerated from 5 per cent to 9.1 per cent.

Thereafter, as CPI inflation climbed up to the double-digits (12 per cent) in 2009 and stayed sky-high until 2013, gold imports headed up to over $50 billion levels. Over the last year and half, inflation has moderated drastically to 6 per cent or so and the import bill has fallen in tandem.

Two, attractive real interest rates seem to be prompting Indian savers to re-allocate their money to financial assets. For much of the period from 2007-2013, thrifty Indians got a raw deal from their financial investments as safe avenues such as bank deposits and small savings schemes offered negative real returns, after adjusting for inflation.

Equity, the only asset class which could have held its own against inflation, also remained moribund in that period. With global gold prices on a tear, bullion delivered healthy double-digit returns in this phase.

Therefore savers, unsurprisingly, shunned financial instruments and parked much of their savings in gold.

But the situation has reversed in the last couple of years. Between December 2013 and June 2015, CPI inflation has tumbled from over 10 per cent to about 5 per cent, a 500 basis point fall. But thanks to a tight-fisted RBI, interest rates on bank deposits have only declined by 50-75 basis points.

With the Centre also opting to keep the interest rates on its small savings schemes at high levels, investors in debt products are, for the first time in seven years, earning a healthy real return. Isn’t that a logical reason to buy them over gold?

The unexpected about-turn in global gold prices during this period has probably given investors further cause for a rethink. In rupee terms, thanks to the fall in global bullion prices, gold has served up a 24 per cent loss to investors who held it over the last two years.

A final explanation for flagging gold demand may lie in the state of the rural economy. With agri-commodity prices sliding without check, the monsoon playing truant and a cutback in rural giveaways from the Centre, consumer goods companies have been complaining of a cutback in rural demand for their products. It is plausible that rural consumers are being frugal with their jewellery purchases as well. In fact, this logic may also extend to rural investment behaviour. Given the dismal penetration of mainstream banking or financial products into Bharat, non-urban savers have for long relied on bullion as a key investment avenue.

These explanations suggest that the Indian households’ romance with gold could well begin where it left off, if the above macro conditions change. If inflation rises again, domestic interest rates tumble or the rural economy revives on a good monsoon, Indian gold buying could easily begin afresh.

The government may have a limited window of opportunity to pre-empt such a situation. A single-minded focus on inflation control and close monitoring of real interest rates may be needed to ensure that household savings continue to seek out financial assets, instead of bullion.

But this apart, it is imperative that rural savers are granted access to savings and credit products that can reduce their reliance on gold. Only then can you convince Indians that gold is truly a barbarous relic.