Household investments in gold are not irrational

Gold is fantastic. Gold is a problem. Depending on who you are, you will choose one of these statements. For Indian households gold has emerged as the investment destination of choice. After declining over the first half of calendar year 2012, third quarter data shows an uptick in demand despite high prices and a higher customs duty. Not only is gold demand up, but that for coins and bars is growing faster than that for jewellery. Coins and bars demand grew 12% over the third quarter of 2012 over 2011 (for calendar year), while that of jewellery grew 7%. Coins, bars and exchang-traded funds are investment vehicles while jewellery is more of a traditional store of wealth for women.

Since India does not have enough gold we import it. Tonnes of it. About 700-800 tonnes are imported each year. Dollars are paid out and 2011-12 saw $62 billion or 3% of the gross domestic product (GDP) flow out of the country to purchase gold. This outflow of hard currency makes our balance of payments a mess. Payments for gold explain a large part of the current account deficit (the shortfall between imports and exports of goods, services, transfers and investment flows) of 4.2% of the GDP. Recent press statements by the Reserve Bank of India and the ministry of finance suggest that the government will announce a gold-linked deposit scheme soon to allow investors the benefits of holding gold without actually buying the metal, potentially reducing pressure on the balance of payments. Opinion pieces and reports on this gold rush of households are condescending in parts—the financially illiterate household knows no better and buys gold. But I don’t think the Indian household is making an irrational choice given the situation that the average household finds itself in. For the un-banked anyway gold has been the only way to accumulate money, but I refer to the switch that household savings have made towards gold and real estate.

A cash-fuelled run-away real estate market (it seems the Delhi real estate market rose 25% after the Commonwealth Games to soak all the cash the over-invoiced bills threw off) has priced real estate so high that the average household sees a large part of the disposable income get eaten up by the monthly mortgage payment. Food and other living cost inflation (caused by supply side blocks that the government has chosen not to address) has seen spending more than double over the last few years reducing the surplus left for discretionary spending and for savings. If the supply side of savings has shrunk, the behaviour of banks and financial product manufacturers and sellers has caused a breakdown of trust causing households to switch their investment vehicles. For example, over 1 trillion have been lost by retail investors in just life insurance products due to sharp sales practices and trap-like products. Grumpy stock markets have added to the retail disenchantment with financial market-linked products while gold returns have been good. Investment in the metal, either buying it directly or through exchange-traded funds (ETFs) has seen ₹ 1 lakh grow to ₹ 3 lakh over the last five years. Over the same period, the Sensex has turned that ₹ 1 lakh into ₹ 94,000. If this was not reason enough, add the overall atmosphere of uncertainty about the future of India and the rush towards gold is explained. Household money has run towards safety. And therefore to gold. To blame the household for causing a balance of payment crisis is uneducated.

End note

The political and governance dysfunction has dented the India story very badly. A year back a senior financial sector regulator in the US spoke to me on condition of anonymity and said that the India story was suddenly over in high finance. “There is just silence about India,” she said. The buzz was over and India will have to re-sell the story. If there is a story left. What a pity, she said, to lose momentum mid-way. Speaking to the managing director of a large private equity firm earlier this week in New Delhi, her words looked prophetic. He was speaking of having to sell the India story all over again to investors overseas—and the story is a bit of a stretch given the political hubris and governance deficit. Worse, he said, not only is the money slow in coming now, the avenues of investment are also slowly shrinking. Sector by sector they are cutting off investment destinations. Not just the household, the smart money is sitting silent as well. Maybe we’ll see the private-equity firms turn to gold.

Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, and Yale World Fellow 2011. She can be reached at expenseaccount@livemint.com