Inflation boosts India’s love affair with gold
Policymakers and economists frown upon it. Financial planners rage against it. But most Indians simply can’t have enough of this “foreign” and “unproductive” commodity. The love of gold unites Indians of all classes, languages, regions, castes, and religions. The secular obsession with gold has ancient roots. But it also has modern underpinnings, research suggests.
The yellow metal’s lustre, malleability, and resistance to corrosion attracted the attention of our ancestors. The Rig-veda emphasises the uniqueness of gold and its story of the creation of the universe refers to the hiranya-garbha, or the golden womb. Since then, it has been used as ornaments for gods and mortals alike.
Some of India’s gold came from within the country. The gold mines of south India and the riverbeds of eastern rivers such as Subansiri (literally golden river) and Subarnarekha (literally golden streak) were among the key domestic sources. The rest came through trade. Indian merchants sold spices and other domestic produce across markets in Central Asia and Southeast Asia and brought back gold and other precious metals. According to some historians, the fabled Suvarnabhumi (or the land of gold) Jataka tales mentioned was a reference to Southeast Asia, whose opulence attracted Indian merchants since ancient times.
The gold obsession is not just about tradition and folklore. Modern economic conditions also play a significant role, the economists Renuka Sane and Manish Singh argued in a Dvara Research working paper published earlier this year. Analysing returns of financial assets between June 1999 and March 2021, they show that gold is an effective hedge against inflation. Inflation-adjusted or real returns on gold have always been positive over this period. Gold also tends to rise during periods of stock market meltdowns, making it an attractive hedge for investors. But it offers a weaker hedge against stock-market volatility than against inflation, their results suggest.
Apart from gold’s resistance to inflationary corrosion and stock market downturns, the currency management policy of the Reserve Bank of India (RBI) may also be adding to gold’s lustre. Gold prices are determined in international markets. So, a depreciation of the currency adds to the price of gold in the domestic market. Sane and Singh’s analysis suggests that RBI has been far more proactive in fighting the rupee’s rise (appreciation) than it has been in fighting the rupee’s fall (depreciation). The “depreciation bias” in RBI’S interventions tends to inflate the imported metal’s returns over the long run, and adds to gold’s attractiveness as an asset class, Sane and Singh argue.
Most economists view Indians’ faith in gold as an irrational and regressive remnant of a mediaeval past. India’s officialdom tends to join them in such condemnation, especially when current account deficits widen, and “non-essential” imports such as gold are identified as the enemies of the State. But Sane and Singh’s research suggests that high inflation, a currency depreciation bias, and limited avenues for asset diversification make gold a “rational” investment for Indian households.
That’s not all. The average Indian investor may also have noted that RBI itself has developed a voracious appetite for gold in recent years. So have central banks of other emerging markets such as Russia and China. They may also have noted that the most powerful central bank in the world, the US Fed (or Federal Reserve), is one of the greatest hoarders of gold. If gold were an “irrational” investment, it should have led to gold divestments by central banks. Instead, advanced economies seem to be hoarding gold while emerging markets with superpower aspirations appear to be raising their gold stakes.
As in the case of households, history and modern-day uncertainty both influence the gold purchase decisions of central banks. The 19th century saw most major economies adopting some form of a gold standard, under which paper money could be exchanged for gold. As the issuer of paper currencies, central banks had to accumulate gold reserves.
Such accumulation reached a frenzy in the early part of the 20th century when major powers such as the US, France, and Imperial Russia raised their gold holdings in the anticipation of war. The US Fed’s gold accumulation continued till the middle of the 20th century. Helped by its rising gold holdings, it took over the role of the world’s leading financial institution from the Bank of England.
Gold holdings of central banks are still determined by country size, the history of being a past empire, and the country’s status as a supplier of a major trading currency, a 2012 National Bureau of Economic Research (NBER) working paper by the American economist Joshua Aizenman noted. The quest for “global power” may partly explain the rising gold reserves of central banks in large emerging markets, he argued. Over the past couple of years, global uncertainties have driven central banks across the world to step up gold purchases.
If sovereigns consider gold as a status symbol and a safe haven in a climate of uncertainty, why expect households to be any different? Till Indian households face a more stable macroeconomic environment, attempts to discourage gold purchases are bound to fail. Attempts to “monetise” gold purchases are unlikely to make much headway for the same reason. India’s love for gold can’t be cured, it must be endured.
APART FROM GOLD’S RESISTANCE TO INFLATIONARY CORROSION AND STOCK MARKET DOWNTURNS, THE CURRENCY MANAGEMENT POLICY OF RBI MAY BE ADDING TO GOLD’S LUSTRE