India’s failure to build trustworthy paper money as another important factor which pushes households towards gold
I
la Patnaik is one of the well-known economists in India. She’s currently a professor at the National Institute of Public Finance and Policy, Delhi. On March 27 of this year, the Indian Express newspaper carried an opinion article by her entitled “The Gold Tax” that offered a welcome new perspective on India’s high consumption of gold in the backdrop of recent economic developments. The article was focused mainly on the distortions likely to arise from the recent move to double the custom duty on imports of gold. But, in getting to her point, Prof. Patnaik also takes the trouble to go into the wider historical and cultural context to our longstanding fascination for gold. In the process, she offers vital insight into the critical role played by gold as a financial asset. Prof. Patnaik begins with the categorical assertion that the recent increase in custom duty on the import of gold and RBI’s move to reduce the loanto-value ratio of gold loans given by NBFCs will hurt the poor. And she cites many reasons in support of this statement. For instance, a simple truth often ignored is that gold is not merely a consumption good but also a financial asset, especially to the poor who are excluded from mainstream finance. What’s more, gold is particularly important in shifting power within poor families to women who get ownership of a financial asset that is liquid, and also doubles up as an excellent collateral when taking a loan. Seen from this angle, gold is about women’s empowerment by stealth. Prof. Patnaik then examines the question why gold continues to attract high demand in India. Her analysis has a broad sweep. Firstly, she links it to our failure in pursuing financial reforms and achieving financial inclusion. Consequently, a very large proportion of households in India are unable to save money in banks, either because there are no accessible bank branches, or because the amounts involved are too meagre to be of interest to the banks. In these circumstances, gold ends up playing a crucial part in financial transactions. And, so long as we do not achieve significant financial inclusion, we have no real option but to respect the role that gold plays for the poor. Secondly, she points to India’s failure to build trustworthy paper money as another important factor which pushes households towards gold. In an environment of persistent inflation, the public loses faith in cash, and gold is seen as a natural hedge against inflation. In fact, even for those who have access to banks, the real rate of return on their savings is negative after
accounting for inflation. In contrast, savings in the form of gold carries the hope that the gold price will keep up with inflation, and the family will get a loan against gold in a time of need. According to Prof. Patnaik, there are many districts where up to 90% of the population does not have access to organised credit. In these areas, the best way to borrow is by mortgaging gold. In earlier days, this was done at a local moneylender but these days, she notes, it’s more likely to be a gold loan company where interest rates are lower. She’s of the opinion that the recent RBI stipulation on increasing the LTV will reduce the usefulness of gold as a financial asset that can be used in times of need. She is categorical that this will hurt the poor who will now be driven back to informal loans from moneylenders or goldsmiths on more adverse terms. Prof. Patnaik counsels the RBI to recognise the fundamental problems in banking, and focus on building a banking system that offers positive real rates of interest. If higher imports of gold are becoming unsustainable, she asserts that the problem has to be solved by increasing financial inclusion and by keeping inflation low and stable. The importance of gold, she reiterates, cannot be curbed simply by having the taxman knock on our doors or by making it harder for NBFCs to give gold loans. In many ways, this article by Prof. Ila Patnaik constitutes a landmark. Perhaps for the first time ever, a mainstream economist has recognised the importance of gold in the Indian economic environment and chosen to speak out in favour of gold loans. So far, gold loans have fallen under the radar of India’s mainstream economists. The reasons are not hard to figure out. For long, gold was thought of as an unproductive asset and hence savings in the form of gold were considered a loss to the productive economy. Much of the trade in gold takes place in cash and accurate data is hard to come by. Economists who love to swear by data were consequently happy to ignore the subject altogether. Besides, the importance given to gold in the Indian social and cultural context has no parallel anywhere else in the world. And so, in the matter of scholarly research into gold and gold loans, there are no readymade templates to fall back on, nor has anyone stepped forward so far to don the mantle of a pioneer in researching this field. In that sense, Prof. Ila Patnaik has broken the mould. She deserves our appreciation.
References: “The Gold Tax” by Ila Patnaik, Indian Express, March 27, 2012, available online at: http://www.indianexpress.com/news/the-gold-tax/928704/0
August 2012 UNIQUE TIMES 15