Also read: Investing in gold? 7 facts you should know
Though the universal acceptance, liquidity and safe haven against economic or political turmoil makes gold lucrative, it does not add much of a value to the economy.
Most of the gold bought by us Indians is used for consumption purpose in the form of jewellery. Even from the investment perspective, majority of the Indians still prefer the traditional way of holding it in the physical form. Gold ETFs, which were first introduced in India in 2007, witnessed slow growth in the initial years. Over the past couple of years, investments in gold ETFs gained momentum.
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However, as per the statistics of Gold Council, jewellery accounts for nearly 75 per cent of the gold demand in India. When we compare this consumption rate with the global scenario, even the second largest importer of gold, i.e., China lags by more than 30 per cent in terms of consumer demand. If we compare these demand levels against the size of economy of major nations, India's GDP is much lower than that of China or the US. The high consumption rate of gold among Indians is unproductive for the Indian economy.
The first major problem the Indian economy faces with this high gold consumption rates is the increasing current account deficit (CAD). India has to pay for its gold imports using its foreign exchange reserves.
Foreign exchange reserves hold a key especially among the developing countries, which have to import and use the industrial metals. Higher consumption of industrial commodities supports industrial production. The goods produced by consuming such commodities can be exported and the revenues can be used to fund the current account deficit. Even during its higher prices, the demand for gold did not go down. The oil imports are a huge burden on India's balance of payments. But oil consumption is something which India cannot reduce keeping its industrial usage in perspective. High gold imports and weak rupee have been the biggest stress points when it comes to narrowing the current account deficit.
Misallocated capital is the second problem faced by the Indian economy due to its gold rush. Keeping the consumption aside, physical gold (mostly jewellery) is also considered as an investment among Indians.
However, it is an investment that does not add much value to the productive capacity of the economy. Investments in the physical form of gold are either stored in bank lockers or get exchanged for making jewellery. It seldom gets traded for money. Imagine the same amount being invested in the capital markets. It allows the companies to raise capital in the form of debt or equity and expand their business. It can make a huge difference to the productive capacity of the economy. It not only just adds to the physical goods produced, it also has a potential to improve employment in a vastly populated country like India.
It is a given fact that over the last decade, gold has given returns which no other asset class has been able to match. However, the demand for gold among Indians has always been price independent. Gold is a traditional investment strategy Indians follow. The effect of high prices has been minimal on the volume of gold imported. The lower prices may increase the demand in the coming days. It is the economies of the US and Europe that play a major role in determining the price movements of gold. By importing gold for our consumption, we Indians are investing in the international markets and helping their economies.
Over the last few years, the Indian markets are supported majorly by the foreign inflows. Participation of Indian domestic investors becomes all the more important for the Indian markets to prosper. Even for the transition of India from a developing market to developed market, it is important that the domestic investors stay invested in the capital markets.
The lack of alternative investments is one of the reasons attributed for Indian investors favoring gold over domestic capital markets. More investors in the capital markets will also drive more investment options in the domestic markets. More than looking at it as an alternative investment, we invest in gold and real estate because we understand it easily.
ArthaYantra is an integrated online personal finance company.
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