Fool’s gold
by Jayant Bhandari  (originally published in the Mining Journal of July 2014)














In the first quarter of 2013 India was facing a current account deficit of 3.6% of GDP. Hypothetically, if all gold imports could be stopped, the majority of this deficit could be erased. Moreover, the money “saved” would have gone—with a bit of nudging from the government—into infrastructure and industrial development, helping with growth and in controlling chronic inflation of around 10%.

A reduced current account deficit would have improved the value of the Indian Rupee – India’s biggest import is rather inelastic demand of oil, made even more inelastic because of the controlled nature of oil prices inside the country. Restricting gold imports was seen as a solution to many of India’s economic woes, while increasing revenue to the government.

The Indian government imposed an 11.3% import duty on all gold imports and created bureaucratic complexities. Given the Indian bureaucrat excels in creating a nightmare for businesses the restrictions were expected to have a massive impact on reducing gold imports. And it did.

Office gold imports swiftly fell, to a trickle. The current account deficit improved rapidly, currently at 0.2% of GDP, and the Indian currency improved significantly in value.

With time it also became increasingly evident that Narendra Modi—seen as decisive, pragmatic and pro-business—would become the next prime minister of India. In May 2014, his party, BJP, won 282 seats and his alliance a total of 336 seats in the house of 543, giving him a clear majority.

All this resulted in foreign institutional investors pouring a massive amount of money into India to buy stocks. This new foreign money has been a very nice icing on the cake, helping improve the federal banks’ reserves. As I write this SENSEX—the key stock market index—is at its highest ever, touching 26,000, having gone up 65% over the past 30 months.

India is now widely expected to exceed China in economic growth and hence become the next growth engine of the world economy.

But I want to challenge all this optimism, for it is based on a facade.

This is an era when even very sophisticated investors no longer worry about more than the next financials. Moreover, political correctness has made it very difficult for people to discuss certain truths or even hold them in their minds.

India is an extra-ordinarily corrupt place. I have never met a bureaucrat who does not expect a bribe. The Indian bureaucrat is a sadist who wants people to demean themselves, grovel and plead, before offering bribes. He then normally does not do what he takes bribes for, if at all he can recognise the giver a day later.

I was in India during the election process. While this is very anecdotal, it seemed that in parts it was about free alcohol, cash and bicycles that were distributed to the voting public. The police and the election officers conveniently ignored what was happening. This was an opportunity for them and the local goons to solidify their traditional bonds. I don’t expect farsighted, enlightened politicians to emerge from such a process.

What about the massive anti-corruption movement that has swept India for the past few years? The reality is that while you must indeed pay bribes for the essentials, for which the blame goes to the government, Indian society will wallow in corruption. I don’t know many middle-class Indians who are morally inhibited in stealing or gaining an unfair advantage over fellow citizens. Ironically, the Indian middle-class individual wants corruption to end, but he wants himself to be exempted.

Corruption runs very deep and wide in the Indian culture in very complex patterns, and is hardwired in the social structure, traditions and beliefs. In this tangled mess are superstitions and dogmas, interplaying with each other and keeping these social vices in place. There is nothing in human history to indicate that when untangling such a predicament happens it is without massive social upheaval and pain. This scares me about the future of India.

Those who grow up in the relatively simpler societies of the West fail to conceptualise the grip of this virus of social, cultural corruption. Lack of skills and problems with work ethic finds its roots here. Fund managers and public policy analysts who think that such problems can be wished away by edicts (as is expected from the decisive Modi) or aid-money fail to understand the complexities and that this kind of change can at best only happen over generations, and only through bottom-up awakening.

Indian GDP is a mere US$1,504 per capita. It is a wretched place, with massive poverty, hunger, and tyranny. Contemplating on the entangled nature of cultural corruption might show to you that those tyrannised when they are empowered become worse tyrants.

With this background let’s come back to gold.

The immediate effect of the imposition of restrictions on gold imports resulted in a premium of about 24% on the Indian retail price (‘premium’ calculated as the differential between the retail Rupee price and the international spot price). The officials imports fell drastically, but most of the gold started to come via smuggling. Smugglers have made an absolute fortune.

Interestingly, competition between smugglers has continued to reduce the premium to what is today – only about 11%, slightly lower than the price of officially imported gold – and a minimal quantity is being imported through official channels to keep a facade of legality.

But hasn’t this at least improved the current account deficit? Yes, but only officially. Dollars that were parked outside India or those that would have entered legally become smuggled gold imports. Eventually this will have more than nullified the positive impact that you currently see on the current account deficit.

India, given its corruption, lack of the rule of law, chaos, wastages and lack of skills that finds roots in cultural corruption – which as I explain above cannot be wished away by legal edicts and charity money – offers a very low return on capital. It is an expensive place to do business, making India uncompetitive in the international arena. As a result, Indian households save their earnings primarily in property and in gold. I see no reason why Indians would want to buy less gold. However, if the economy stagnates, which I think is likely, Indians will feel that much more constrained economically to buy more gold. As a corollary, you might expect gold consumption of Indians to fall, if the international price goes up.

Jayant Bhandari

Jayant Bhandari is senior analyst with Anarcho Capital, which advises institutional investors about global investment opportunities. He previously worked for six years with US Global Investors and a year with Casey Research. Before emigrating from India, he started and ran Indian subsidiaries of two European companies. He travels regularly to India and takes an active interest in understanding and writing about the Indian economy and culture. He is an MBA from Manchester Business School (UK) and B. Engineering (computers) from SGSITS (India).