India’s Golden Problem

The legendary Indian obsession with purchasing gold has been passed down for generations. Families purchase gold on auspicious religious occasions and, in larger quantities, for weddings. It forms a significant part of savings, particularly in rural areas, and is often passed down as inheritance. Today, however, it is also being credited as one of the main reasons for India’s spiraling current account deficit, which has widened to a record 6.7% of gross domestic product in the latest period.

A country’s current account is the sum of its balance of trade – in other words, net revenue on exports minus payments for imports. India imports vast quantities of gold to cater to its local demand and, at a time when the global economy is still sluggish, Indian firms are unable to export as much as they used to. The net result is the spiraling deficit, which is chiefly responsible for the drag on the exchange rate of the Indian rupee.

Since the government cannot do much about boosting exports in a slow global market, the focus is on cutting imports. But as India’s Chief Economic Advisor, Raghuram Rajan, has pointed out, there is not much that the government can do about the country’s vast imports of oil or coal – both of which are essential for supplying the country’s energy needs and ensuring the smooth functioning of the economy. Gold imports, on the other hand, are unproductive investments.

When gold prices softened by over 20% earlier this year, as a result of a lowered appetite for the metal as a safe haven investment, many were hopeful that India would spend less on imports. This would then narrow the current account deficit and strengthening the currency. However, the lower prices sparked a massive buying spree. According to a report by Biman Mukherji in The Wall Street Journal, it is estimated that gold imports saw an extraordinary 130% year-on-year increase in April, at a time when prices were down 10% year-on-year. The staggering rise in volumes has further widened the deficit and brought it to a dangerous high.