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India's Love of Gold - 2

The Macro view of India's Gold Consumption

May 27, 2002

India is the largest consumer of gold in recent times. The recent World Gold Council figures estimate Indian demand of gold in 2001 to be 843.2 tonnes comprising 26.2 % of the total world demand! This is sure to surprise many considering that India is considered a very poor country with one of the lowest per capita incomes in the world. India is estimated to hold more than 11,000 tonnes of gold.

70% of the population lives in rural India where agriculture is the main activity. 65-70% of the gold purchase is done in the rural areas, which is largely dependent on agriculture although agriculture forms only about a third of our GDP. Agriculture is highly dependent on the rains and hence the rural disposable income is quite dependent on the weather. A good year for agriculture assures higher demand for gold as in 1998/1999. Additionally gold has less competition from other avenues for savings and they would not trust the new-fangled vehicles like mutual funds anyway. Rural folks are very conservative.

Vijay Sarda, a Mumbai-based bullion dealer and past vice-president and presently a director of Bombay Bullion Association, makes two very important points:

The main reason for such high rural demand for gold is non-taxation of agricultural income. If the agricultural income would be taxed, the disposal income would be substantially reduced resulting in lower gold demand.
In the rural areas, the womenfolk especially have a low level of education. Hence the middle-aged rural male will invest more of his savings into gold so that womenfolk in his house can encash their wealth without legal hassles and having to deal with strangers.

The months from October to January and April and May constitute the main marriage season and also have a large number of festivals. Hence demand for gold is very strong during these months.

The figures of the past few years show that Indian demand for gold has consistently been hovering around 25% of total world demand as the following table shows:

GFMS - Gold Survey 2001.

WGC - Gold Demand Trends, May 2002.

For 2001, Average Rate is estimated at US$ 270 per troy ounce (oz) and Rs 47 per US$.

India was the world's largest gold market prior to 1962 and Bombay (new name is Mumbai) was the main trading center. After the Indo-China war in 1962, due to loss of reserves, the government enacted the Gold Control Act, 1962 prohibiting the citizens of India from holding pure gold bars and coins! The old holdings in pure gold had to be compulsorily converted into jewellery that had to be declared. Only licensed dealers were allowed to deal in pure gold bars and coins. New gold jewellery purchases were either recycled or smuggled gold.

This legislation killed the official gold market and a large unofficial market sprung up dealing in cash only. The gold was smuggled in and sold through the unofficial channel wherein many jewelers and bullion traders traded in smuggled gold. A huge black market developed for gold.

Gold was smuggled into India in the size of 10-tola bars (called a TT bar in trade parlance). The traditional Indian measure for gold is "tola", a name derived from the Sanskrit word "tula" for scale or balance, and one tola is equal to 11.664 grams. Hence a 10-tola bar weighs 116.64 grams. "The size of the 10-tola bar enables it to be easily concealed -- specially designed smugglers' vests hold around 100 bars in 20 or more pockets. It has smooth, rounded edges so that it can be inserted inside a smuggler's body -- up to eight bars in the rectum. Another important feature is that the bar has no serial number, unlike almost all other cast bars available on the international market. That made the ten-tola bar the gold currency of choice, especially from 1947-1992 when India strictly regulated gold imports, giving rise to a massive black market. " (1)

Additionally, the 50's to the late 80's were a period when India embraced socialism with a passion. The government moved towards a controlled economy wherein all the factors of production and resources were controlled and licensed. This led to nothing more than corruption and shortages resulting in profiteering by the businesses. In 1990 India had a major foreign exchange problem and was on the verge of default on external liabilities. The Indian government pledged 40 tonnes from their gold reserves with the Bank of England and saved the day. Subsequently India embarked upon the path of economic liberalization.

The era of licensing was gradually dissolved. The gold market also benefited because the government abolished the 1962 Gold Control Act in 1992 and liberalized gold import into India on payment of a duty of Rs 250 per 10 grams (periodically the government feels obliged to fiddle with the duty structure if it works well). The government thought it more prudent to allow free imports and earn the taxes rather than to lose it all to unofficial trade -surprisingly a very pragmatic view. This expanded the gold market while reducing the quantum of trade and the profit margins in the unofficial channel. According to the WGC figures, from official imports of practically nothing in 1991, India officially imported more than 110 tonnes in 1992 whereas smuggled gold maintained at about 160 tonnes in 1992 and gradually declined thereafter. The official imports grew from 1992 and now the official imports are about 600 tonnes peaking at 663 tonnes in1998.

Gold smuggling that was on the rise again last year due to high excise duties has subsided this year after the government has again reduced the duty to about Rs 2914 per TT bar in addition to local taxes. India is the most price-sensitive market for gold in the world.

According to GFMS, the smuggling channels have become more efficient (reduced number of seizures and lower costs). "Gold enters India via a number of different routes. The trade routes are complex but can be divided into two distinct categories - direct flows and indirect flows. Direct shipments (mainly official) in the main are from the refining centers of Europe, South Africa and, to a lesser extent, Australia. Indirect flows tend to move through the two entrepots of Singapore and Dubai in the first instance. Direct and indirect flows out of Hong Kong are small. The smuggled gold flows through the indirect channels" (2).

In the first quarter 2002, demand in India has fallen by 40 % to 150 tonnes from 250 tonnes in 2001. However, as discussed earlier, this has been partly compensated by the huge quantity of the retail sales (dishoarding) by the masses which is being recycled in the Indian market. On a visit earlier this month to a gold dealer's shop, I was surprised by the long line of people who wanted to sell their old gold jewellery. Out of curiosity I asked why they were selling and the routine response was that this is a very high price and it may or may not sustain! Unfortunately these folks have never heard of rupee devaluation and gold as a barometer of inflation. I mused at what their emotions would be six months later! I also believe that once the gold price breaks out, the masses will stop selling and start hoarding again.

Referring to the table above, we see that the gold demand is stagnating at a nominal value of about Rs 350 billions for the last four years. Now, as the price of gold rises the billion rupee question is:

Will the amount of gold demand be constant or
Will the nominal rupee value of gold demand be constant resulting in lower quantity of gold demand?

I would hazard that the answer lies somewhere in between. In fact, I feel a lot of the money may be pulled out of the financial markets (equities, bonds, fixed deposits, and mutual funds) and be redeployed into investment in gold bullion as the latent desire and affinity for gold re-awakens in the Indians' minds and hearts!

An important event to note was the rationalization of the local taxes in Maharashtra in April 2002. This move will concentrate the gold trade back to Mumbai (new name for Bombay) and I would not be surprised to see Mumbai reemerge as one of the largest gold trading centers in India and maybe the world.

As George Bernard Shaw's said, "If you have to choose (as a voter) between trusting the natural stability of gold and the natural stability and intelligence of the members of the government, with due respect to these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold." The people of India have seen the historical behaviour of their government with regards to gold and the fact that politicians and governments cannot be trusted, so gold (official and unofficial) has a very bright future here!

To prove the point, the government had launched a gold deposit scheme in September 1999 to utilize the idle gold and simultaneously give a return to the gold owner and reduce the country's reliance on imports. This scheme has flopped as the citizens have taken Shaw's advice to heart!

Part 1 Part 3

Pinank Mehta

May 27, 2002

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