While India's total imports and transfers are
higher than its total exports and transfers, the Current Account Deficit (CAD)
was at 30-year record high of 4.2 percent of the GDP in 2011-12. High levels of
CAD lead to the deterioration in the currency value, which eventually bruised
the economy. High levels of CAD forced government to discourage what they think
are not necessary and hence in a bid to do so they jacked up the import levy on
gold. Policy makers point out that one of the primary drivers of the CAD has
been the growth of almost 50 per cent in imports of gold and other precious
metals during last year. Policymakers have blamed India's addiction to gold
contributing to the problem on the external account and have taken series of
steps involving duty increases to curb imports and consumption. Are gold imports
to be blamed and labeled as "unnecessary"? Is it a burden on the
country?
At least, the data for the last
few years suggests that gold has been a reliable asset to depend on when
macro-economic conditions globally & domestically were not favorable for
investors.
There are a few misconceptions
that need to be cleared and few points that need to be
reiterated.
The relentless pressure on the
rupee is a constant reminder of the fact that we are running an unsustainable
Current Account Deficit. This has made us hostage to the ebb and flow of global
risk appetite.
Data Source:
Bloomberg
We need to accept the fact that
CAD is India's structural problem, not merely a cyclical uptick driven by strong
domestic growth. The data should make this abundantly clear. In 2011-12 we
posted the lowest GDP growth rate of 6.5% in the last nine years. Yet, we
simultaneously recorded the highest CAD-to-GDP ratio (4.2%) in post-independence
history. In short, the CAD is not the result of high imports to fuel high growth
- it is instead a manifestation of unsustainable structural
imbalances.
Going further, a simple analysis
of the inter-linkages between savings, investments and the balance of payments'
CAD shows that the predominant component of savings is India's domestic savings.
The India Growth Story of the 2000s was fuelled essentially by domestic and not
foreign capital. There is disproportionate policy focus on foreign capital
inflows, rather than on domestic savings. While the objective at the present
time is to stimulate domestic savings, there is a great divide between what
should be done and what is being done.
In India, growth is relatively
high, inflation is raging and interest rates are not high enough to offset
inflationary pressures. In a situation where the stock market is extremely risky
and inflation has hits savers, it is no surprise that intelligent savers are
flocking to gold, thereby increasing gold prices.
The Chinese government is
explicitly encouraging individuals to allocate their assets to gold. But, the
Indian government is finding ways to discourage it. If the current negative
interest rates continue it would not be surprising if savers flee from bank
deposits. As far as the question of inflation measurement goes, the authorities
continue to swear by the Wholesale Price Index (WPI), that doesn't include the
cost of services, which does not reflect consumer prices (end-user price). The
world over, the Consumer Price Index (CPI) is used as an indicator of inflation.
CPI is more indicative of inflation that the common man faces. The CPI is, in
general, a better indicator of inflation than a wholesale price
index.
In India, governments, from time
to time, have toyed with the idea of introducing inflation-indexed bonds, but on
each occasion the authorities have backed off. The real reason for rejecting the
indexation idea is that governments do not trust their ability to control
inflation. If the government is serious about the welfare of the disadvantaged
segments of society and the elderly, it should be willing to float inflation
indexed bonds at least for senior citizens. The scheme should offer a real rate
of interest of only 2 per cent per annum; if the CPI at the end of the year
shows an increase of 10 per cent, the saver should be paid a nominal rate of
interest of 12 per cent for that year.
The elderly need to be protected
from inflation through instruments that promise a real rate of return of, say, 2
per cent over the rise in consumer prices. This would also do well to set
inflation expectation low. The move will, in fact, signal the government's
intent to contain inflation. Instead of being apprehensive about floating an
inflation-indexed bond when the CPI inflation rate is high, as at present, the
government should launch the scheme at precisely such a time. It would act as a
signal that the government is determined to bring down the inflation rate to
very low levels. A determined move by the government can alter inflationary
expectations.
The fiscal deficit is out of
alignment with the medium-term objective of fiscal consolidation. The gross
fiscal deficit (GFD) for 2012-13 is estimated at 5.1 per cent of GDP as against
5.9 per cent in the previous year, but there could be serious slippages in
2012-13. Rating agencies have already issued warnings of downgrades. In short,
the macroeconomic situation is uncertain and the political economy instability
reflects in concerns about governance. Despite strong assurances and determined
body language that hard policy options would be taken, political economy
requirements do not give credence to such intentions. Government needs to bring
its house in order to first create domestic conditions that enable citizens to
take decisions to participate in the India's growth story.
Gold purchases have increasingly
become a key element of the portfolio choice of households in an environment of
economic upheaval and high macroeconomic uncertainty.
The idea should be to develop
conditions to divert people from gold. The idea of government forcing
individuals to choose investment sounds like "Too much Government". If an
individual wants to save his money in the form of gold, he should have the
opportunity to do so. Government should not tax gold, silver or any of the
precious metals. It just is arbitrary and against the rights of the citizens to
choose their own investments. When the government cannot control the valuation
of rupee which seems to go southwards every year with respect to almost all of
the acceptable currencies, why should a citizen not hold gold or dollars or
Euros instead of rupee or rupee based investments.
The side effects:
The government's efforts to curb
gold imports may have resulted in the collateral damage many feared - a
resurgence of smuggling. There's no official data but indications are abound.
Cases involving gold seizures at airports have risen 10-fold in recent months,
confirming the worst fears of critics that the strategy to raise duties to
control imports of the precious metal would spawn a revival in its
smuggling.
Between April and June this year,
authorities impounded gold worth Rs 942 crore in some 200 cases of smuggling, up
272% on Rs 243 crore in the year-earlier period that involved 20 cases, as
reported by the economic times article citing finance ministry data. During the
same period, India's official gold imports fell 56% to 131 tonnes, data from the
World Gold Council showed, reflecting the impact of higher duties and rising
prices. Has consumption really fallen or illegal means make up for the
shortfall? "What should investors do?
Gold is not the problem but is
really a symptom. In other words, soaring gold prices is an issue but it is not
a root cause for the country's woes. Trends in gold consumption and prices tells
us too many things about the macroeconomic environment prevailing. Increased
gold consumption is a signal of imprudent policies prevailing in a country
driving people towards gold consumption.
Gold prices have continued to
increase. There was an acceptance amongst the masses that interest rates have
peaked and thereby were seeking to lock in deposit rates when they are high.
This led to some diversion of flows to deposit. With some cut in deposit rates
announced, they might not be more attractive on a real basis. The negative
interest rate scenario is driving flows in gold. With the official numbers
signaling a slow down, it needs to be assessed. And, with the recent revival in
gold consumption seen, will the government look at ways to reduce intake or look
at working towards an environment that automatically reduces our consumption; in
other words peoples reliance on gold
Investors should consciously
allocate a pre-determined percentage to gold to insulate themselves from the
impact of high inflation often driving policy rates into a negative territory on
a real basis. Gold works as an effective portfolio diversification tool and
thereby adds more value.
Data Source: Bloomberg, World Gold
Council
Regards,
Chirag Mehta
source: Quantum Gold Fund
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