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All That Glitters is Not Gold: A Vicious Cycle Kunal Delwadia & Varun Kumar Srivastava

IIM Kashipur

IIM Kashipur

"ALL THAT GLITTERS IS NOT GOLD: A Vicious Cycle There has been now a lot of debate going on about the gloominess spread over the Indian economy. The numbers are speaking for themselves. Indias share of worlds trade is less than 2 percent and makes up less than 6 percent of the global economy. Yet, it accounts for 25% of the worlds gold demand. Indeed, this upsurge in gold demand has now become a bottleneck for our countrys economy. A cursory glance at gold import and consumption date shows that gold buying has been inelastic to GDP growth changes in recent years. It has remained at 800 to 1000 tons per annum. If the impact of increased import duty on gold and other restrictions imposed to curb gold consumption is not taken into account, there may not be an appreciable change in the gold consumption behaviour in the country. For Indians proclivity for gold is timeless. The gold buying spree is not just limited to special occasions like weddings or festivals; it is more of a symbol of supremacy, beauty, power and status. A traditional value for the gold is sacrificing the Indian currency and economy to a large extent. The recent trend in the gold demand and supply has repositioned this fair. However, gold is considered as the liquid cash to be used for emergency in Indian culture. The Indian perspective of investment is quite different in context of risk-taking. Investing is that application of ones earnings or an asset that gives financial return as income while keeping the capital invested protected from the loss. In this context, it differs from the basic fact of gaining the monetary benefits than protecting the capital, which is readily available during financial emergency. Gold and silver however combine the advantages of both investments and savings provided they are accumulated regularly over a period of time. Indias love affair with gold is not new. India is the world's biggest gold importer, soaking up a third of the world's supply every year. By buying up billions of worth of foreign gold, we send Indian cash overseas, disrupting the balance of payments and thus driving down the value of the rupee that in turn makes key imports more costly and makes it harder for business to pay its international loans. However, what has happened in the last few years is that rising gold imports has coincided with a rise in inflation and weakening of rupee against the dollar continuously from Rs 48 to 63. The combined impact has served to widen the current account deficit (CAD), which is the net outflow of money from the country.

Source: Business Today, Author: Sanjiv Shankaran Article: Yellow Peril edited on June 13th 2013 A closer analysis of the situation reveals the root cause of the current Indian economic condition. A major driver of the impact is inflation driven by the import of the gold completing the vicious cycle of blocking Indian currency under the bed sheets and lockers. The inflation and loose government finances together created these conditions that aggravates the situation even more for other imports. Inflation, for instance, made it tougher for exporters to compete and not to forget huge government subsidies on the oil imports. Gold purchases in this context, are a symptom rather than a cause of Indian CAD. But the RBI picked up huge gold loans to be the root cause of driving the inflation above the controllable limits. Gold is the Indias biggest import commodity after oil. The impact? The CAD is 4% of GDP, about double what economists have recommended. Data with the RBI shows gold was responsible for 20percent of the trade deficit between fiscal years 2007 and 2009. Subsequently, in the next two years, with inflation raging, that number rose to 30percent of the trade deficit. Therefore, our Finance minister Mr. Chidambaram appealed to the citizens to stop buying gold that can make huge positive impact on the CAD and change the game for us. If for one year there are no gold imports, it will change the current account deficit of the country said Finance Minister. Indians think they are buying gold in rupees. Actually they are buying gold in dollars.

Source: Google Images While Indias current account deficit is too high, the real concern is whether enough money is flowing into the country to make up the difference, Bibek Debroy, an economist affiliated with the New Delhi-based Centre for Policy research said in an interview with media. Gold is synonymous with savings and security for many of Indias 1.24 billion people, for a variety of reasons. Only about 36,000 of India's 650,000 villages have a bank branch. And minimum balances and other requirements means that house maids, security guards and construction workers hold much of their assets in gold coins and jewellery as a hedge against bad times, when they can be sold or used as collateral with the local money-lender. And with both the capital markets and real estate losing lustre lately, India's wealthier have emerged as a new class of gold buyers. Traditionally, theres always been a demand for gold. Is investing strategy of savings and security a bad methodology of investment, especially for a country like India where people have strong emotional attachment? Probably a rise in gold prices is unlikely without a big slump in the US stock market or in the value of the dollar, neither of which seems likely. And even considering long term, gold prices tend to skyrocket and plunge because there's paltry real business demand for the yellow metal, with investors who buy gold and sit on it as an investment accounting for more than half of the volume purchased every year. For the Indian economy, however, the gold obsession is worse than a poor investment. Unlike buying stocks or bonds, parking money in gold, rather than stimulating the economic growth, is sucking the cash out of the

system. (In contrast, even oil imports, while bad for the trade deficit, actually fuel the industry). Meanwhile, a growing trade deficit forces the country to devalue its currency for India, about 10 percent a year for the past two decades. Those plunging values scare people out of rupees, and foreign funds out of India, which in turn, means less investment and slower growth, eventually weakening the rupee even further. Across, global market I believe it could be wise to say that, Gold has indeed lost its glimmer.

Works Cited Shakaran Sanjive, Yellow Peril, Edited on June 13th 2013 Accessed on 24th Oct 2013, 3.30PM Overdorf Jason, how a gold fetish is killing Indian Economy, Dated 16th June 2013 Accessed on 24th Oct 2013, 4.00PM Report 4 (Unknown Author)Gold: Why and How does it impact the Indian