Home/ Opinion / Views/  The gold loan business owed its glitter to a macro shift

A ‘macro shift’, as used here, is a long-term structural shift that can reshape economic activities and markets. Macro shifts have an outsized impact on stock markets because the accompanying churn reorders winners and losers. Indeed, some of our big stock market success stories owe their exalted status to an underlying macro shift becoming a powerful tailwind for their business. For example, the exponential spread of internet access at ever-increasing speeds laid the ground for tech-enabled services to achieve global dominance. Closer home, India’s emergence as a software export powerhouse followed the adoption of computers by American businesses intent on reducing labour costs and gained from advances in satellite communication which make outsourcing viable. The swell of unicorns created by India’s startup landscape owes much to our digital payments infrastructure. The most powerful macro shift of recent years has been a gush of money pumped into the world economy. Liquidity in response to the Global Financial Crisis of 2008 kicked off a prolonged regime of rising asset prices with across-the-board gains for global stock and bond indices. Covid-relief liquidity also meant easy money flowing from near-zero interest rates. Hordes of cash-burning tech startups attracted hefty valuations to become stock market darlings, even though profitability was not in sight.

Another business that benefited from a macro shift was that of gold loans, or lending money to retail customers against gold jewellery. It plucked a couple of Kerala-based non-banking financial companies (NBFCs) out of obscurity and put them into national headlines. The macro shift at work here has to do with the price of gold. The international price of gold saw an unprecedented bull run from 2001-02 to 2012-13, rising from an annual average of $272 to $1,653 per troy ounce over 12 years. The incline was even more pronounced in India, where currency depreciation is also a factor. Indian gold prices rose for 14 straight years, soaring from an average of 4,268 for 10gm in 1998-99 to 30,164 in 2012-13 (i.e., annualized gains of 15%). Notably, the first seven years (up to 2005-06) saw milder increases, with annualized gains of 7%. Over the next seven, however, gold was on fire, recording annualized gains of 23%.

Gold loans are, at heart, commodity-based finance where price risk is the lender’s main risk. Collateral values dropping below outstanding loan amounts is often a cue for defaults to surge. But thanks to a macro tide, gold loans remained relatively sheltered from its biggest risk for 14 years. No wonder then that this was when India’s two top gold-loan firms, Muthoot Finance and Manappuram Finance, recorded dizzying growth in their loan books. They were early-movers and in 2005-06, halfway into the gold bull run, their combined gold-backed portfolio amounted to less than 900 crore. By 2012-13, that figure had boomed to about 36,000 crore (i.e., 7-year compounded annual growth of 69%). Clearly, this dramatic performance was enabled by a soaring gold price.

The era of gold prices moving relentlessly up is over for now, as subsequent increases have seen sharp moderation. That explains, at least partially, the relatively sedate growth of gold loans thereafter. Over the next nine years up to 2021-22, the combined gold loans portfolio of Muthoot and Manappuram more than doubled to 77,400 crore, but this time at a modest 9-year compounded annual rate of 8.9%. The price of gold went up at an annualized 5% in this span. Admittedly, with banks muscling their way into gold loans with cheaper offerings and new-age fintech firms queering the pitch further, heightened rivalry has affected the big two as well.

Can this business reclaim its glitter? If 14 years of upward gold prices gave early movers a safe harbour, consider what happened afterwards. Indian prices fell by about 4% annualized for three consecutive years after 2012-13. This was also a time of major regulatory changes for the industry, with stringent norms coming into force overnight. Gold-loan NBFCs lost business and customers, and their profits took a dive. Nonetheless, they kept their heads above water and did not lapse into losses. After years of de facto protection, this infant industry was seasoned enough to ride out the downturn.

Can gold loans regain those glory days anytime soon? Well, any suggestion that gold is again headed for a multi-year bull run will evoke scepticism, given recent years of volatility with no sustained upside breakouts. Still, powerful tailwinds are seen gathering for gold. Firstly, there’s an impetus for de-dollarization driven by non-Western central banks seeking to diversify their external reserves away from the US dollar, now seen as exposed to politically motivated sanctions. Second, gold has for long served as a hedge against inflation and currency debasement. The US is battling inflation at a multi-decade high. Past experience with inflation has been unforgiving, as interest rate hikes take a heavy toll on the real economy, with an occasional nasty surprise (like bank trouble) to set markets on edge. This pressures central banks to prematurely ease off on their hiking cycle, but any let-up risks deeper trouble, like a sustained phase of stagflation.

That is when gold will likely get another glittery moment in the sun. As for gold loans, not so much. Because, with many more players in the business to share business fortunes now, the spoils will be spread thinner. The opportunity for a select few to corner the gains, as happened during the last bull run, will just not be there. That ship has sailed.

Ranjan Sreedharan worked for over a decade with a gold-loan NBFC.

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Updated: 20 Mar 2023, 10:30 PM IST
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