Gold is not all glitter

Over the last six months, India closely escaped a downgrade by global rating agencies and the major reason is a sense of purpose and urgency shown by finance minister Chidambaram, ever since he took over in Aug 2012. It is still going to be an uphill task till the next elections. A One of the key metrics giving a difficult time is the Current Account Deficit (CAD), which is the difference between payments made for imports (of goods and services) and the payments received for exports. Our CAD as % of GDP has progressively increased from around 1.3% in 2007-08 and is predicted to be above5% in 2012-13.Oil import has been a major contributor to the CAD for a long time and will continue to be so till the time global prices decline or there is reductionin domestic demand. The chances, of either outcome, are highly improbable in near future. Blessings never come in pairs and misfortunes never come alone. In last few years, the increase in domestic demand and global prices of gold have both added to the CAD. A To subdue the domestic demand for gold, the government added an import duty of 2% to raise it to 6% in January 2013. But this did not make a big difference to consumer appetite. Some of this consumption is not run of the mill.As per a recent news report, a Pune based financier had a shirt tailored for him. It is made of 3.5 kgs of 22�carat gold and cost him Rs 1.27 crores. A leading industrialist, whose house was publicised to be one of the most expensive in the world, had all the staircase railings in this house made of gold. And in a case of crossing the line between luxury and depravity, by a wide margin, an undisclosed client engaged a designer to make an entire toilet seat of gold. Gold demand may only increase with these innovative uses! Over the last few years, two developments in the financial markets have the potential to further increase the indirect demand for gold. The first is the rapid growth ofgold loan NBFCs (non-banking finance companies).

These companies were reported to be following lax lending practices, charging highinterest rates and providing loans up to 85 % of the value of the gold. The Reserve Bank of India (RBI) stepped in with some controls.But still, the ease of availing loans from these companies has increased their customer base and if the price of gold rises, the demand for gold loans and gold would keep pace. The second development has been that of increase in innovative instruments, like gold mutual funds and ETFs (Exchange Traded Funds), which allow more sophisticated investors to park their money in gold backed securities without physically holding them. From 2007, when the first gold backed ETF fund was launched, to now, there are 14 fundofferings that hold around 40 tonnes of gold.A After real estate, gold constitutes the biggest component of unaccounted wealth in India. Most transactions are done using cash and values are under-declared by sellers. Anytime the government tries to implement tax compliance practises, like declaration of PAN (permanent account number) for transactions above a certain value, the powerful lobby of jewellers subverts the entire process.With this background, a large increase in VAT (value added tax) may also prove to be ineffective. Apart from its historical significance as a reserve for securing currency during older days, gold does not serve much useful purpose.A There is limited industrial use and much of it is deployed for jewellery and as an item of investment. Even in terms of investment returns, gold has been a laggard over an extended long term. Warren Buffet, the renowned investor, had this to say about gold in 2011:

"All the above ground gold would make a cube that is 67 feet tall and worth $7 trillion dollars. For $7 trillion dollars, you could have all the farmland in the United States (and) you could have about seven Exxon-Mobil (world's highest valued oil company), and you could (still) have a trillion dollars of walking-around money. And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and touching it and fondling it occasionally. Call me crazy, but I'll take the farmland and the Exxon-Mobil(s)." Studies have shown that an improvement in stock market and real estate returns are negatively correlated to gold demand. Maybe, the easiest way out of this situationfor the government is take steps to improve the economy and build investor confidence. It will take care of a lot of other problems along with our gold import bill. OPINION