June 18, 1997
Mobilizing Indias Gold Reserves for National Development
Over the next decade, India needs to invest several hundred billion dollars in the infrastructure needed to support national development. Power, roads, ports and education need to be expanded considerably to support higher rates of productivity and growth. Investment in the power sector alone could absorb $100 billion or more. Investment in housing and roads can absorb thousands of crores and generate millions of jobs, without any demand for foreign exchange. The combined requirements far exceed the amounts available for investment by the public sector. Providing attractive conditions for foreign private investment is one option, but this would long term outflows not only for debt repayment as well as repatriation of high profits on foreign owned assets. This might be acceptable if there were no other alternative, but India has a more attractive option.
Indias Gold Reserves
Indias love of gold makes it unique among developing nations. It is a country in search of enormous sums of foreign investment to support further investment in infrastructure, while at the same time even greater sums are being held by the public in the form of non-productive savings as gold. According to a recent report, India possesses approximately 29,000 tons of gold valued at roughly $300 billion, of which only 400 tons is held by the Government and the remainder is in private hands. This huge reserve represents national savings taken out of circulation and unavailable for further investment in the nations development. The gold saving habit continues unabated. Last year India imported approximately $3 billion in gold.
Gold has both a financial and sentimental value in India. It is a hedge against inflation and devaluation of the rupee. In the form of womens jewelry it is also a traditional symbol of economic security, wealth and social prestige. Any effort to change savings habits has to address both these factors to be successful. Two strategies are presented for tapping this huge reservoir to support developmental investments.
Incremental Strategy to Reduce Additional Savings as Gold
Indias gold pool is growing every year as new families are formed and new wealth is converted into jewelry. In addition to the continued drain on the nations foreign reserves, this form of savings is also disadvantageous because it earns no income for the investor, is difficult to transport and vulnerable to theft. The fear of theft and loss is so great that most families store their jewelry in banks and many women wear artificial jewelry to social events.
One strategy to gradually discourage the gold habit is to introduce Gold Savings Bonds that can be issued by RBI or the nationalized banks. The bonds would pay interest, perhaps at half the level paid on normal fixed deposits, and be redeemable in gold at maturity. The bonds would appeal to investors both because of the interest they earn as well as their ease of transport, storage and greater safety. They would retain all the financial security possessed by gold. Banks could also offer more favorable loan terms on these bonds than is presently given for jewels.
Although the bonds would not be expected to completely displace additional gold investments, they would serve as an additional or alternative form for families that already possess sufficient jewelry. The lower interest paid to the depositor would enable banks to set aside funds to purchase gold futures as a hedge against increases in the international price of gold. Even if initially only 10% of additional investments went into bonds rising to 50% over a decade, this strategy could make $15 billion dollars or more available for investment the economy. These funds could be lent to the private sector for investment in priority sectors such as infrastructure and education. However, this approach would not be likely to have a significant impact on the countrys existing gold reserves.
Strategy to Leverage Existing Gold Reserves
The countrys existing reserves could be made available for investment in development if the public comes forward to lend them to the banks for extended periods of time, so that the reserves can be utilized as security for raising international loans or expanding the domestic money supply. The funds raised could be channeled into investments in infrastructure projects such as power, roads and telecommunications, eliminating the necessity of seeking large amounts of foreign private investment in these sectors. Depositors could be offered a low rate of interest on their gold deposits, backed by government guarantees. Based on the gold reserves, Indian banks should be able to raise funds internationally at very attractive rates and lend those funds to Indian business for investment in infrastructure. This proposal would not be inflationary, since much of the funds raised would be utilized for purchase of capital goods abroad and the investments would be made in assets that will greatly contribute to growth of national productivity.
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