How a gold fetish is killing India’s economy

NEW DELHI, India — Across global markets, gold has lost its glimmer.

Investors are fleeing the yellow metal, whose price has slumped more than 10 percent over the past three months.

But Indians are so gold crazy they're sacrificing their currency and their country’s economy in the bargain.

By buying up billions of dollars worth of foreign gold, they are sending Indian cash overseas, disrupting the balance money entering and leaving the country, 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 international loans.

"If for one year there are no gold imports, it will change the current account deficit story of the country," said Finance Minister P. Chidambaram on Thursday. “Indians think they are buying gold in rupees. Actually they are buying gold in dollars.”

India is the world's biggest gold importer, soaking up a third of the world's supply every year. Gold is the country's biggest foreign purchase after oil. The impact? The current account deficit (the net outflow of money) is 5.4 percent of GDP, about double what economists recommend.

"I once again appeal to everyone to resist the temptation to buy gold,” Chidambaram said. “This will show positive impact on every aspect of the Indian economy.”

While India's 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 Center for Policy Research, told GlobalPost. And there things get extra tricky.

“The worry for the government really is that whatever capital inflows we have are in the nature of portfolio investments” — such as stock purchases — “which tend to come and go,” Debroy said. In contrast, direct investment in factories and in other ventures tend to carry long-term benefits, and the capital remains regardless of short term market fluctuations.

“So we should really be asking, ‘Why aren't investments coming in?’ — rather than picking on people who are buying gold.”

According to Chidambaram, India's gold imports fell from an average of $135 million in the first half of May to $36 million in the second half of the month, but he neglected to mention the reason: This year the Akshaya Tritiya festival, the second-biggest holiday for buying gold, fell on May 13.

The post-holiday lull gave some relief to the central bank, which on Tuesday was forced to intervene in currency markets to bring the rupee back from its lowest level against the dollar in history (58.98 rupees to the greenback).

But the rupee resumed its fall after the finance minister's speech Thursday. And the dip in gold demand is likely only to be temporary — because for Indians gold is more than an investment.

Gold is synonymous with savings and security for many of India’s 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 mean that house maids, security guards and construction workers hold much of their assets in gold coins and jewelry as a hedge against bad times, when they can be sold or used as a collateral with the local moneylender.

Moreover, the metal's cultural importance makes it essential for weddings and various other ceremonies. Even bankers and lawyers still think of buying gold jewelry as a foolproof financial strategy. And with both the capital markets and real estate losing luster lately, India's wealthy have emerged as a new class of gold buyers.

“Traditionally, there's always been a demand for gold. But what has added to that in the last four years or so is a different kind of demand. That is a demand for gold that I would call investment,” said Debroy.

“There is quite a bit of investment in gold now that is actually in bullion.”

Consider this: Even though gold prices have plunged from more than $1800 in November to around $1400 an ounce last month, the World Gold Council has forecast that India's gold imports for April-June would amount to almost half the total imported in 2012.

Bad investment? Probably. Experts say 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 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 slows, rather than stimulates, economic growth by sucking cash out of the system. (In contrast, even oil imports, while bad for the trade deficit, literally fuel 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. That, in turn, means less investment and slower growth, and thus a further weakening rupee.

In other words: A vicious cycle.