India And Gold

The Indian government made headlines recently with its attempts to obtain possession of the gold held by its citizens. It claims it is in the national interest to restrict gold imports, which would reduce India’s trade deficit. Accordingly, Indians are being asked to deposit their physical gold in the banks for a promised yield of 2½%.

The government said the gold will be used to supply jewellers and other domestic users, replacing imports. Furthermore, the government announced the launch of a gold-backed bond, which in the words of Prime Minister Modi, and I quote, “People will not get any gold bar but a piece of paper that will have the same value as gold. When you return that piece of paper you will get money as per the value of gold at that time. You will not need to buy gold and worry about where to keep it.”

The World Gold Council is lending its name to the coin issue, which is part of what the government is calling, with disarming honesty, its gold monetisation scheme. However, only 4 kilos will be minted initially in 5 gram and 10 gram coins, so it looks like little more than a PR stunt for the wider scheme drawing in the authenticity of the WGC.

Wisely the public, both as individuals and also as representatives of religious communities, are having none of it. They are obviously not interested in sharing possession with the government, and the response to the deposit scheme attracted a paltry 400 grammes in the first two weeks. The media speculates this is due to the reluctance of people to declare their assets because of tax implications. While there may be some truth in this, the real reason may be far simpler but unquotable: people do not trust the government with their gold.

People have cause to be wary. The Indian government has a long history of destroying personal wealth. The Nehru dynasty embraced far-left socialist policies, until their Congress party was finally dismissed in 2004. It was then natural for India’s new Prime Minister, Manmohan Singh, to fully embrace Keynesianism, which as capitalism with a socialist heart is universally attractive to politicians. Consequently, there remains a hard core of anti-saver and anti-sound money mentalities at the heart of the Indian government, despite the impressive success of India’s current economic policies.

Government economists portray the trade deficit as a private sector problem. However, the private sector always pays for its goods, even if they are imported, and it is impossible, other than through timing differences, for the private sector to generate a trade deficit on its own. Trade deficits are always the consequence of government interventions and monetary inflation, so the excuse of gold imports being responsible for trade deficits wears thin. It is more a case of the Indian government having always wanted to obtain its peoples’ savings for its own ends. The attraction of the current gold scheme to the government is that it hopes to acquire tangible gold in exchange for paper issued out of thin air. The argument that if people didn’t import gold, the deficit would magically disappear, therefore is propaganda.

The history of this approach to deficits goes back a long way in India. Capital controls were first introduced by the British as a wartime measure in 1942, and after independence these grew into a complex set of restrictions where violations were treated as a criminal offense. The introduction of the first Gold Control Act in 1962 banned gold loans by the banks. This was followed by the 1968 Gold Control Act, which specifically prohibited ownership of bars and coins. These acts were a huge mistake, because they led to a thriving smuggling trade that even fed into drug trafficking and other black market activities. Public demand for gold continued apace, and the Gold Control Acts were finally repealed in June 1990.

However, the Indian government continued to regard the public’s acquisition of physical gold as hoarding assets beyond the reach of the state. Gold imports rose to record levels in 2012, after which the government imposed a series of import duties through 2013, which predictably only fuelled smuggling activities. It seemed that the lessons of history were being ignored. However, this coincided with the appointment of Raghuram Rajan as Governor of the Reserve bank of India, the central bank.

Rajan had been the chief economist at the IMF for three years between 2003-06. He became a respected establishment figure, and would have had the full backing of the Bank for International Settlements. He believes strongly in deregulation and can be credited with monetary policies that have successfully reduced the rate of price inflation, while fostering significant economic progress. His appointment has been an undoubted success. However, Rajan has been central to the re-imposition of control restrictions on gold, contrary to his deregulation principles, and which he must have known would not succeed.

The global context is key to understanding this contradiction, because western central banks were and still are privately concerned about the rapidly growing demand for bullion from both China and India. These nations, with a combined population of 2½ billion people, were absorbing considerably more than mines and scrap recycling could supply, draining European vaults and leading towards a potential gold crisis in capital markets. For this reason, the strong circumstantial evidence is that Rajan was effectively appointed by the west’s central banking establishment with a mandate to rein in Indian buying of physical gold.

All Rajan’s attempts at imposing taxes and re-export quotas on bullion have failed abysmally, to no one’s surprise, and have been mostly rescinded. The current gold monetisation scheme smells like a renewed attempt to deflate public demand, a Plan B coinciding with Diwali, when demand is at its highest and likely to place considerable stress on depleted western stocks. This could reasonably be interpreted as evidence of growing panic in western central banking circles, and that the original plan to deflate India’s demand for bullion has failed to deliver.

India’s Future In Asia

India’s planned membership of the Shanghai Cooperation Organisation is the motivation behind the shift in policy from merely discouraging imports, towards a policy of state acquisition of privately-owned gold.

As a future member of the SCO, India together with the other members will have roughly half the world’s population. India’s seamless integration is imperative for both her and the SCO, and will help secure India’s future economic prospects. But to get the most from her membership she will have to conform with the SCO’s common economic and monetary policies. India is succeeding remarkably well in the development of her economy, but she has a big problem with the money aspect.

Given India’s size, she has too little gold for membership of an organisation that will almost certainly incorporate gold into its monetary system. Both China and Russia as senior SCO partners have aggressively accumulated bullion, which together with Chinese private sector demand, accounts for the majority of global mine supply. Furthermore, these countries are the two largest miners, accounting for 700 tonnes annually between them and there can be little doubt that some of this is withheld from global markets. It is clear from their actions that gold is intended to be incorporated in the yuan and the rouble in a fashion yet to be disclosed, and that the leaders of these countries believe gold is central to the SCO’s future success. The extent of their support for sound money policies and the success of the future monetary regime is arguable, but that is not the point. The point is if India is to secure her future position in Asia and the SCO, she must have gold, and lots of it.

The Indian government managed to acquire 200 tonnes from the IMF in 2009, to take her holding up to only 558 tonnes. She cannot acquire additional gold in sufficient quantities through market purchases, particularly if her own citizens are competing against her for bullion. Of course, there would be no need for the government to own huge reserves if it is prepared to let markets operate freely. This has been a basis of Chinese policy since 2002 with its government actively encouraging its citizens to accumulate gold for themselves, even going so far as to advertise the benefits. It is clear that China recognises the need for gold to be widely distributed among its population as part of a comprehensive monetary policy. But India is constrained by a combination of general government distrust in free markets, and her commitment to the Bank for International Settlements to help control the gold market by reducing private sector demand.

India’s government therefore sees no option but to obtain sufficient gold from its citizens to hold down its future position in the SCO. And if the current gold monetisation scheme fails, the ordinary Indian and his temple will be faced with the prospect of outright government confiscation.

Indian citizens should be alert to what is going on behind the scenes, and western observers should follow this story carefully. The Indian government is on course to do what every government does to get its citizens’ gold, by fair means initially and foul when fairness fails. Once their gold has gone into the government coffers, the Indian people will never ever see it again.

Alasdair Macleod | Head of Research