India’S Unprecedented Appetite For Gold

As the decade-long surge in gold prices moderates, trends ahead may help explain India’s unprecedented appetite for the metal in recent years. To what extent was this driven by the global boom? And how much did domestic factors like inflation contribute? Disentangling the respective roles could offer useful lessons for future economic policies.

The issue is of interest from an Indian perspective, for past inflation episodes haven’t been accompanied by such a large-scale shift towards gold as has happened since 2008. Gold imports grew 42% annually in 2008-12, shrinking 2% in 2012-13 as import duties were raised to narrow the current account deficit. In the same period, global gold prices increased an average 27% annually, in large part fueled by the creation of global liquidity by advanced countries’ central banks. Gold is priced in dollars, so when the dollar’s value gets debased, investors reposition their holdings in favour of gold establishing a positive relationship between quantitative easing and gold prices.

The Indian lust for gold is commonly ascribed to high inflation. Consumer price inflation averaged 10% each year from 2009 to 2011, while real interest rates were negative over 2009-10 from loose monetary policy. Savers shifted to physical assets like gold from financial assets like bank deposits; deposit growth nearly halved from 20.4% in 2008-09 to 11.4% by 2010-11, recovering thereafter as monetary policy settings were adjusted.

Inflation alone however may not account for this extraordinary gold appetite. Given the coincidence with the global boom, portfolio factors possibly played a role. Gold outperformed all other assets in this period, offering savers annual returns in excess of 25% in 2008-11. Bank deposits compare poorly with that, even if real rates are positive as happened in 2012 -- gold demand remained undampened, inviting fiscal restraints. Income growth was strong too—in the four years to 2011-12, Gross Domestic Product growth averaged 7.7% annually, while per capita incomes grew an average 6% each year. Indian gold demand is highly income elastic.

With the US monetary stimulus in reversal mode, its economy recovering firmly and interest rate increases on the horizon, the settings are now reversing for gold. Global gold prices fell 28% in 2013. A changing global macroeconomic framework may thus reflect in India’s gold demand. Moderation to long-term trend levels will help highlight the role of future macroeconomic policies. For example, global liquidity that enters in the form of capital flow surges when combined with exchange rate appreciation, rising incomes and import demand, consumption and asset price boom, as was the case in 2009 and 2010, along with high inflation. Monetary policy alone then cannot curb gold demand; fiscal measures would be more effective instead.

Source:- livemint.com