This week, there was great volatility in gold, which will have its uses for sure. Tuesday witnessed the steepest single-day price decline in seven years, which is now making bankers wary of storing up future troubles by writing subprime loans (which are risky), against the precious metal.
Indians own one-eighth of the metal ever mined. This in itself clears out how much of an emotional appeal gold has for us Indians. And of late, this glitter had begun to blind authorities too. RBI had very recently raised the loan-to-value limit for advances against jewelry in gold from 75 to 90 percent.
Now, in one day, international prices have fallen by 5.7 percent. The next day, they jumped by 1.3 percent. With such low margins of safety, banks are naturally uneasy and in a spot. There is a risk that they might end up giving loans that will not be repaid.
Lenders, however, are pushing borrowers to take up new gold-backed loans to then repay their delinquent unsecured credit, after the central bank declared a moratorium on repayment ends. Even if the money does not come back, they can at least sit on the commodity.
Back in 2008 during the ongoing crisis, Americans had walked away from their underwater mortgages by posting house keys to banks. India might have a similar kind of a jingle mail when borrowers start to put their self-interest above all, especially their cultural love for gold; especially when the value of the collateral is dropping considerably.
One can easily blame the pandemic for all this. As per the Centre for Monitoring the Indian Economy, salaried jobs are harder to revive as compared to the informal occupations in the Indian scenario. Unsecured consumer credit is also drying up, and the middle class is now being forced to monetize their rainy day hoard to be able to survive.
Prime Minister Modi’s appeals to families to part away with their idle 25,000 tons was not very convincing for us Indians. In a five-year-old program to wean Indians off gold, only 20 tons have been deposited. Indians did not fall for the chance to earn interest when they could have when they had the capacity for self-insurance instead. Now, the country went into a sudden lockdown in March.
If households also lose their gold by borrowing more than what they can pay back, how will they accomplish to navigate the next crisis?
A recent rally took prices above $2,000 per ounce, and this has now prompted other proposals to put gold to use. One suggestion is for the RBI to transfer its 618 tons of metal at cost to the government, and then repurchase it at 90 percent market value. This would give New Delhi the equivalent of $31 billion in freshly minted money to repair and revive the economy.
However, both the plans, raiding the RBI’s war chest, or asking people to deposit off their gold with the government for a few years, are unnecessary distractions.
If India was facing a BOP difficulty and needed dollars, monetizing gold would have been a good idea. But this is not the case here. The foreign exchange reserves soared past $500 billion. Domestic liquidity is not in short supply either.
Even before the pandemic, the country was in a multiyear investment funk, which drained the system of its risk-absorbing capital. Earlier, tax collections were faltering, now they are cratering. The post-lockdown recovery will likely be a long slog too.
Thus, consumers are looking at gold to survive and the government is looking at it as a tool for the revival of the economy.
The central bank is not in need of parting with its gold and buying it back to support deficit financing. Indonesia’s case of openly monetizing budget shortfalls well offers a sane alternative, given that India can convince the market that temporary print and spend will only lift future growth, by plugging a chunk of the capital crunch.
Utilizing the central bank’s gold to raise resources is not a substitute either to boost credibility with investors. Pushing households to do so will bring back neither their salaried job nor their lost income stream. And now that gold has blinked, India will be able to evaluate other options too!