Home >opinion >Why do we count gold imports in the current account?
Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Why do we count gold imports in the current account?

Over April, May and June 2013, Indians would have bought 300-400 tonnes of gold.

Why do gold imports get counted in the current account and not the capital account in a country’s balance of payment (BoP) accounts? The origin of the question stems from the unfairness of the wholesale blame that Indian household gets for soaking up a quarter of the yearly world demand for gold that costs an outflow of billions of dollars from India. I hold the view that the Indian household makes a sensible decision to hoard gold. It is sensible because access to financial assets remains difficult and where access is easy, the regulatory failure to stop large-scale cheating of retail investors, as in the unit-linked insurance products that cost us 1.5 trillion in lost money, has broken the fledgling faith in markets for the average investor. Regulatory and institutional failure is the reason people hoard gold and not because they are stupid. And as the country looks more and more unstable, we buy more and more gold—perfectly logical and rational. This is no different than industrialists moving their business overseas and the rich buying real estate and stock abroad. Since the average household can’t do that, it buys gold. Over April, May and June 2013, Indians would have bought 300-400 tonnes of gold, a jump of 200% over the same period last year. Retail investor issues rarely wrinkle the brow of policymakers, why then this uproar over the average Indian’s fetish for gold? It worries people who get worried over the country’s finances because paying for this gold causes our BoP to get unbalanced.

From what little economics I can remember, I know that the current account measures the flow of goods and services in and out of a country. What a country gets minus what it spends on goods and services and transfers from the rest of the world. Basic household finance will tell us that it is better to be on the plus side of this math—we should get more than what we pay. India has a hole in this account—it’s called the current account deficit (CAD). And a chunk of this CAD is explained by gold imports. So, why is the CAD important? It is an indicator of the economic stability of a country. A large sustained CAD indicates large overseas borrowing and/or sale of domestic assets to the rest of the world. A sudden reversal of financing can cause a run-down of the reserves and a look in the mirror with bankruptcy. Therefore rating agencies monitor this number very carefully. The capital account measures the payments to and from a country for sale of assets. So, the question for us in India is this: do we consider gold to be an asset or not? And if it is indeed an asset, why is it sitting on the current account side of the BoP? Basel III norms have included “unencumbered" gold to be used as longer-term funding, but with a 50% write-down.

I’ve obsessively asked this question and have got some very interesting replies. Economist Ajay Shah of the National Institute for Public Finance and Policy gives two reasons why gold should not be part of the capital account: “One, jewellery is unproductive. You eat chocolate, you buy earrings. Two, the whole world does this so for comparability of BoP data across countries we have to follow the standard convention. And suppose we did move it, the CAD would become smaller and the capital account would show this strong outflow, where Indian households are taking money out of the country to get invested in (say) gold ETFs in London."

Nilesh Shah, director of Axis Direct and a strong proponent of moving gold to the capital account, pushes back on this view, “if it is global standards, then India should follow the way the US counts its inflation—an Apple upgrade that results in a price hike is not counted as inflation but more money for extra features. Swiss banks don’t believe in uniform disclosure. So let’s not be selective about what global standards we want to follow." Shah strongly believes that by moving gold to the capital account and accounting for remittance and software exports, India’s trade deficit for financial year 2011-12 of $57 billion would have turned into a surplus of $5 billion.

Another argument against the idea comes from an economist who prefers to remain unnamed. He says: “We have to distinguish between a good question and a good idea for India to implement. I think the question is a good one—there is an ambiguity in the way in which the item enters the current account and the capital account." Should we move gold out of the current account and breathe a bit easy on the CAD? No, he says. “Making the switch at this point of time will fool nobody for long. Most people will catch on and see this as yet another desperate measure by a government that is not able to implement meaningful policies and interventions to get growth going. Worse, the capital account inflow would get smaller as households take out money to buy foreign gold."

I remain unconvinced that moving gold to the capital side of the equation is a bad idea. What do you think? This is not to say that we don’t need to get our economy back on track, but along with that—why shy away from using properly an asset for which the average citizen has a fetish?

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

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