Why the Indian Government’s War on Gold will Fail

Prime Minister’s Economic Advisory Council (PMEAC) Chief C Rangarajan has declared that India’s love affair with must be contained. Gold imports must be substantially reduced from 1,000 tonnes a year to 700 tonnes.

The imperative to contain gold import has become urgent. The recent surge in gold demand is however creating some distortions and need to be rolled back to boost growth by reversing the trend of declining financial savings and keeping CAD* within prudent limit by contain gold demand.

*CAD-Current Account Deficit

India’s government has essentially placed the burden of the Indian economy on gold. And in doing so, they justify the reinforced holistic campaign against the precious metal.

Coincidentally, India’s stepped up war on gold comes amidst the ongoing Wall Street incited crash.

The Mineweb’s Shivom Seth wonderfully explains how the campaign against gold by India’s government is being orchestrated through various fronts. 

First India’s government proposes to provide an inflation hedge alternative: government inflation indexed bonds (bold mine)

It could have posed as a model scheme to curtail gold imports. In order to stifle India’s appetite for gold, the government has introduced inflation index bonds. The first tranche amounting to around $364 million (R20 billion) is to be introduced on June 4.

Inflation Indexed Bonds (IIBs) are a new category of debt instruments to be introduced in India, where the coupon and principal amount would be linked to the rate of wholesale price inflation with a lag of four months. The authorities have said the objective of introducing such bonds is to channelise savings into productive sources of instruments from unproductive ones like gold.

Slowly but surely, there seems to be an anti-gold campaign that is at play in India. The concerted effort by the Indian government to discredit gold by imposing several curbs, and channelise consumers away from the precious metal, indicates a desperation that has not gone unnoticed by savvy investors.

“The government is making it too expensive for retailers to sell gold, especially when prices have hit new all-time lows. Retailers are forced to apply hefty mark-up given the new curbs,” said Manohar Kedia, of Kedia Jewellery House.

Government inflation indexed bonds are being forced upon the average Indians, as the Indian government’s onslaught to curb the gold trade has intensified. 

India’s war on gold now covers higher taxes or tariffs and import bans and limits.

Knowing fully well that Indians cannot keep away from gold for long, the Reserve Bank of India first hauled up banks for selling gold coins, then came down hard on gold retailers and bullion houses. Now, they have turned their attention on investors, urging them to invest in debt instruments.

Further, in order to moderate the demand for gold for domestic use, the government has also restricted the import of gold on a consignment basis. A major bullion retailer in Mumbai said this would prove to be a major hurdle for exporters.

For, only those exporting gold jewellery will first have to impose on banks for each consignment, given that banks will henceforth be allowed to import gold only to meet the genuine needs of exporters of gold jewellery.

The Indian government's genuine but unstated objective have been to capture or corral people’s savings, by diverting them into the government regulated or controlled banking system, and use such savings to finance a chronically insatiable and profligate government.

India's "declining financial savings" has hardly been because of gold but because of rapacious government spending.

India’s government has more than doubled the rate of spending over the past 9 years. Such spending binge has exploded the the government’s budget deficits since 2009. (charts from tradingeconomics.com)

The intensive growth in food subsidies has been part of the such spending spree, as shown by the chart above from the Reuters. Food subsidies are expected to swell by about 40% in 2014.

The Indian government has been subsidizing many industries. Subsidies according to Wikipedia accounts for 14% of the the Indian economy in 2015 (note: not government budget). 

Yet subsidies has led to huge losses: as much as 39% of subsidized kerosene has been  stolen, and as I pointed out last year, politicians looted food subsidies to the tune of $14.5 billion!

Aside from food subsidies, the Indian government has joined the global bandwagon of stimulating the economy nearly a year ago or in June 2012, with various forms of fiscal spending mostly in infrastructure. Thus the spending ratios should be more today

Such lavish spending has resulted to expanding the debt.

Even as debt to GDP has been shrinking, the Indian government’s external debt has massively ballooned over the same period. 

This only means that the accrued government spending has been funded by debt acquired from external sources.

Again the debt to gdp metric is hardly a reliable statistical indicator because the denominator (GDP) can be driven by a credit boom and not by real growth. This is currently the case with India. India’s domestic credit to private sector has reached the highest level ever at 50.6% in 2011. India has an ongoing bubble.

While India’s foreign reserves remain near record highs, exploding fiscal deficits and ballooning external debt has led to sustained weakness in her currency, the Indian rupee.

In short, the frantic Indian government has been passing the blame on gold on what truly has been a problem of political greed via fiscal intemperance.

Importantly, the Indian government’s attack on gold represents a duplicitous move. 

While the government wants access on the private sector’s savings via the banking system (which aside from funding governments will incur various taxes and fees), the desire to reduce the public’s gold holdings by holding paper money, the rupee, means governments would also impose “the inflation tax”. 

So bank depositors will be hit by low interest rate, inflation tax, various fees and will be forced to hold and finance government debt, in favor of the government (who may default).  

One can’t rely on statistical inflation figures to accurately represent real conditions. Statistics are likely to be manipulated for the purposes of financial repression or government plunder of private sector resources. Thus, much of the average Indians will unlikely fall for such 'inflation indexed bonds' subterfuge.

So like anywhere else, governments have been resorting to direct and indirect confiscations with increasing frequency and intensity. 

Signs of boom days eh?

More entwined reasons why India’s war on gold will fail.

Gold has both cultural and monetary essence to the average Indians.

As the Deccan Gold Mines enunciates: (bold mine)

Over centuries and millennia, gold has become an inseparable part of the Indian society and fused into the psyche of the Indian. Having passed through fire in its process of evolution it is seen as a symbol of purity, the seed of Agni, the God of fire. Perhaps this is why it is a must at every religious function in India. Gold has acted as the common medium of exchange or the store of value across different dynasties in India spanning thousands of years and countless wars. Thus wealth could be preserved inspite of wars and political turbulence. For centuries, gold has been a prime means of saving in rural India.

Next as related to the cultural-religious context, India’s history has been littered with economic crises and even currency problems

To account for a recent history here is Wikipedia

Since 1950, India ran into trade deficits that increased in magnitude in the 1960s. The Government of India had a budget deficit problem and therefore could not borrow money from abroad or from the private sector, which itself had a negative savings rate. As a result, the government issued bonds to the RBI, which increased the money supply, leading to inflation. In 1966, foreign aid, which was hitherto a key factor in preventing devaluation of the rupee was finally cut off and India was told it had to liberalise its restrictions on trade before foreign aid would again materialise. The response was the politically unpopular step of devaluation accompanied by liberalisation. The Indo-Pakistani War of 1965 led the US and other countries friendly towards Pakistan to withdraw foreign aid to India, which further necessitated devaluation. Defence spending in 1965/1966 was 24.06% of total expenditure, the highest in the period from 1965 to 1989. This, accompanied by the drought of 1965/1966, led to a severe devaluation of the rupee. Current GDP per capita grew 33% in the Sixties reaching a peak growth of 142% in the Seventies, decelerating sharply back to 41% in the Eighties and 20% in the Nineties.

Aside from the rupee chart above, the following table shows how the rupee slumped relative to the US dollar from a conversion rate of 4.79 rupee/US in 1950 to 45.83 rupee/US in 2010.

One would also notice that from a base point of zero in 1975, inflation surged to 126 in 2010. And despite the plummeting rupee, through 1975 per capita income as % of the US has gyrated from 1.5% to 2.18%. This means that whatever growth India has posted over the years has failed to keep at the rate of the growth in the US. 

In short, devaluation has not solved what has been a problem of politicized economy.

This brings to fore the lessons from the great Austrian economist Ludwig von Mises

The economic backwardness of such countries as India consists precisely in the fact that their policies hinder both the accumulation of domestic capital and the investment of foreign capital. As the capital required is lacking, the Indian enterprises are prevented from employing sufficient quantities of modem equipment, are therefore producing much less per man-hour, and can only afford to pay wage rates which, compared with American wage rates, appear as shockingly low.

There is only one way that leads to an improvement of the standard of living for the wage-earning masses — the increase in the amount of capital invested. All other methods, however popular they may be, are not only futile, but are actually detrimental to the well-being of those they allegedly want to benefit.

What India requires is not to regulate or prohibit gold but to further liberalize or depoliticize the economy. 

Unfortunately politics is about smoke and mirrors rather than the upliftment of the general welfare

Another huge reason such campaign will fail is due to the informal economy. 

The informal economy means low banking penetration levels.

From DNB.com.in

With regard to financial access and penetration, India ranks low when compared with the OECD countries. India offered 6.33 branches per 100,000 persons whereas OECD countries provided for 23-45 branches per 100,000 people in 2009. For India, the number of branches and ATMs per 100,000 persons has increased to 7.13 and 5.07 in 2010.

In India, the penetration of banking services is very low. Merely, 57% of population has access to a bank account (savings) and 13% of population has debit cards and 2% has credit cards. This represents the unmet demand and the scope for expansion for the banks in India.

And prohibition of gold and offering inflation indexed bonds as alternative will hardly improve on banking penetration levels hobbled by overregulation.

And because of intensive politicization of the Indian economy, a significant segment of India’s growth has been in the informal economy

From Businessworld/Bloomberg: (bold mine)

The size of India’s “informal” economy, meanwhile, handicaps efforts to track the number of Indians who are gainfully employed. Four out of five urban workers—who collectively produce an estimated three-quarters of the country’s output—are informally employed. That means their work does not show up in official figures on productivity, innovation, social mobility and other standard metrics of progress. It’s possible to debunk some of the myths about India’s work force—three-quarters of self-employed workers in urban areas, for example, are in single-person businesses or family enterprises without hired labor, rather than upwardly mobile entrepreneurs—but a clear picture of exactly how many Indians are working, and where, remains elusive.

The informal economy, hence, represents political or government failure from which India's government has taken gold as the 'fall guy'.

Finally, gold fits to a tee the informal economy

From the Economist (bold mine) 

Pune’s wide boys aside, the traditional gold consumers are southern peasants buying jewellery. They have no access to formal finance; gold requires no paperwork, incurs no tax and is liquid. But over the past decade the mania has spread. By weight consumption has doubled, for several reasons: a surge in money earned on the black market; investors chasing the gold price; and the dismal returns savers get from deposit accounts. Real interest rates are low, reflecting high inflation and a repressed financial system that is geared to helping the state finance itself.

Another significant factor why the war on gold will fail is political insanity: doing things over and over again and expecting different results. 

Attacking gold as part of financial repression measures has previously failed, it shouldn't be different this time

From the same Economist article:

India has tried coercion. Between 1947 and 1966 it banned gold imports. After that it used a licensing system. Neither worked. Smuggling soared and policymakers were reduced to tinkering with airport-baggage allowances. By 1997 trade was liberalised.

All these political pretenses which are really intended as confiscations of private savings whether through gold, cash transactions, bank deposits or bitcoins (cryptocurrencies) will eventually be exposed for the fraud they are.

India's war on gold will only intensify the growth of smuggling and the informal economy.  

India's war on gold signifies also an expression of growing desperation by the Indian political class over their hold on power whose economy has partly been buoyed by credit bubbles.

India's war on gold could likewise be a part of the grand design of the cabal of political institutions or the banking system, central banks and welfare warfare states led by Wall Street in working to preserve the current unsustainable system by spreading disinformation and by the manipulation of the markets in order to dissuade the public on currency alternative options as gold or bitcoins.