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In the past decade, Indians imported gold, silver and gems worth an aggregated value of $515 billion. After adjusting gems and jewellery exports of $319 billion with a nominal profit margin, Indians exported savings of $227 billion in foreign currency. Outward flows exceeded the combined debt and equity inflows by foreign institutional investors (FIIs), $190 billion, or net foreign direct investment (FDI) inflows of $174 billion, in the same period. In what is a criminal wastage of capital, India remitted more money abroad than what it received in FDI or FII inflows in the past decade. If we had retained and wisely invested the $227 billion within the Indian economy, it would have created an additional trillion-dollar-plus economy with more jobs, better growth, stronger currency and more prosperity. It would have kept some of the bluechip Indian companies under the majority Indian ownership.

Indians imported gold despite already being the largest owners of gold in the world. More than half of the gold was bought after prices of the metal corrected from highs of mid-2011. Gold is notionally liquid. Banks, for instance, only sell gold; they can’t buy gold. Jewellers won’t have enough liquidity to buy even a fraction of current gold holdings. Apart from that, not only does gold carry a 10% import duty, but also a premium of 5-30% for smaller denominations, creating an instant loss for the buyer. Making charges on jewellery are quite high. Quality of gold remains an issue despite hallmarking. Gold prices have fallen more than 40% since mid-2011 in dollar terms and 18% in rupee terms since mid-2013.

Therefore, it is strange that despite low returns, illiquidity, quality issues and upfront losses, Indians kept on buying gold throughout the past decade. What is driving this behaviour? Following factors are potentially responsible.

 There are more jewellers than there are financial product distributors. An appropriate network of distributing financial products with comparable incentives and similar regulatory mechanism does not exist to help Indians move from gold to financial assets. Prosperity of an average jeweller versus that of a mutual fund agent shows why more gold is sold than equity mutual funds. The gold trade has no regulatory oversight such as know-your-customer norms. One can sell small gold coins at 30% premium, unlike financial products. We need to bring gold investment at par with financial products in terms of regulatory overview by implementing KYC, demat holding, prescribed manufacturer’s margin and set distributor incentives.

 Despite efforts from various regulators to spread financial education, the average investor has been a slow learner. Retail ownership of gold and gems is higher than the retail ownership of bank deposits, mutual funds, insurance or direct equity. Provident fund (PF) money has been invested in debt, which has barely given real returns. Organised sector employees haven’t tasted the benefit of investing in volatile but richly rewarding equities through regular and long-term investment which PF offers naturally. No wonder the number of mutual fund investors is lesser than those with PF.

It is important to spread financial education in the common man’s language rather than in jargon. It is also important to make financial education part of school and college curriculum. In fact, gold can be taxed to raise funds for spreading financial education, especially in non-metro areas and in regional languages.

 A lot of demand to invest in gold and gems originates from the parallel economy. And most of the gold and gems are imported from a limited number of entities. So, it’s possible to track major buyers. Swift and heavy punishment for misinformation will ensure cooperation. Apart from this, closer to the ground, most jewellers now have surveillance cameras. So, one can track cash purchases from video recordings and spot transactions that indicate tax avoidance. Doing so could create strong deterrence.

 The rules and procedures for entry into financial markets end up deterring retail investors. Buying gold is infinitely simpler than buying a financial product. No wonder more systematic investment plans (SIPs) run with jewellers for buying gold than to buy equities through mutual funds. Even today, it is not uncommon to see in a place like Mumbai, migrant labourers standing outside a bank branch, rather than inside, to remit money. If this is the scenario in Mumbai, one can imagine what must be happening in non-metro branches. There is no common KYC across financial products. Having completed the process with, say, a bank, is not good enough for a mutual fund investment. KYC with a mutual fund is not good enough to open a broking or a demat account. KYC done in the same bank is not good enough for opening another account in the same bank. There is no portability of KYC in banking like in mutual funds.

We need to simplify purchase of financial products, or, make buying gold and gems more difficult.

Financial education, deterrence from tax authorities, easing entry into financial markets and appropriate distribution networks will go a long way in making domestic capital available for economic growth.

Nilesh Shah is managing director, Kotak Mahindra Asset Management Co. Ltd.

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