RBI report condemns ‘excessive’ gold demand

Reserve Bank of India working group recommends gold imports are reduced to protect the country’s balance of payments and currency reserves

A Reserve Bank of India working group believes the country's demand for gold imports is a major source of India's "bulging trade deficit" and must be curbed.

The working group was created to study gold-related issues, in particular whether large gold imports are a threat to India's external stability. In a draft report of its findings, released on January 2, the group raised concerns the gold-driven increase in India's current account deficit threatened its ability to maintain an adequate foreign exchange reserves buffer.

India's current account deficit hit 4.2% of GDP in 2012, up from 2.7% the previous year. Between 2009 and 2012, gold contributed nearly a third of India's trade deficit.

A spokesperson at the World Gold Council acknowledged the importance of keeping a large current account deficit in check, but warned that buying less gold could stifle the gem and jewellery industry. The central bank's report also says that in India gold jewellery carries a great deal of sentimental value, while the acquisition of gold is considered auspicious.

Gold - as a protector of assets - is also important during periods of economic uncertainty, the World Gold Council spokesperson said. "It has a key role to play in hedging against currency risk and inflation, both prevalent economic issues facing India today. We believe that the fundamental reasons for buying gold will remain as strong as ever," the spokesperson added.

India's demand for gold increased by 11.9% and 10.7% in 2011 and 2012 respectively, the report notes, while changes in global gold supply were -5.7% and 2.5% in 2011 and 2012.

The Indian government has already taken steps to reduce demand. In 2011, India imported 589 tonnes between April and October. During the similar period in 2012, the number fell to 398 tonnes. This is partly due to the increase in customs duty levied on imports, the RBI report said, and the central bank expects demand to continue to fall.

In addition, the working group said it is "critical" to divert investors' attentions away from gold by ensuring there are other financial products available that provide real returns. Importantly, the report said, this will involve the creation of gold-backed instruments.

Such instruments would also help put the country's idle stocks of gold to productive uses, the report said, and could include a scheme where gold is taken as a deposit and recycled, or a pension product where gold is surrendered to a bank in return for monthly streams of income.

Another option the working group suggested to mobilise domestic gold was to reconsider the creation of a ‘gold bank', an institution - under the RBI's oversight - equipped to import, export, trade, lend and borrow gold, and deal in gold derivatives.

In an extreme situation, the report said, limits on the volume and value gold banks can import should be considered, while bank financing for purchases of gold bullion could be prohibited.

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