MG 277 Public Policy Theory and Process

TERM PAPER

‘Trade Policy-Gold Impact on Indian Economy

29-April-2014

Swapnil Soni

SR No: 10134

Department of Management Studies

Indian Institute of Science

Bangalore 560012

1 Gold impact on Indian Economy

Swapnil Soni, Department of Management Studies, IISc Bangalore
Introduction

Exploration, generation and delivery of the wealth are the social and economic activities of a country by which
it meets the demand of the nation to attain ultimate development with equitable growth. Each country has a
certain geographical and demographical advantage and shortcomings so all need cannot be met by a single
country independently. Thus countries exploit the competitive advantages of other countries by trade and
negotiations. In order to prevent own resources and strength from negative externalities of trade nation frames
law comprising certain restrictions and provision, called ‘Trade Policy’. In the huge basket of commodities for
trade bullions play a pivotal role in a country’s economy. Gold is considered base of foreign exchange and
currency of some countries. More than economic value it has its own social and esteem value in some countries
especially in India. In much of Asia, the Middle East, and the Indian subcontinent, gold is the best possible
protection against upheaval, both political and economic. For men and women throughout the developing world,
gold is still one of the most liquid and widely accepted forms of exchange, quite simply the most efficient store
of value they possess.

As we know that India’s domestic production of gold is very limited, the rising demand has to be sourced from
outside the country. Moreover, Gold as a commodity on its own does not add much to the productive capacity of
the economy. When one buys gold, it either is stored in lockers or gets converted into jewellery. In both the
cases, money spent on purchasing gold gets blocked since gold is not a productive asset

In India Gold is more than an economic agent. It is the social status symbol. Its high liquidity and sustaining
economic value have escalated its position to pinnacle. Thus having observed the role of Gold in Indian
economy it can be said that Gold portrays the outright association of culture and value with Indian economy.

In this context this paper will serve following purpose:

A. Roles of Gold in Indian economy

B. Evolution of Gold Policy in India
C. Statistical analysis of Gold trade & Indian economy
D. Recommendations
A. Roles of Gold in Indian economy

India imports most of its gold requirement. Gold as a commodity on its own does not add much to the
productive capacity of the economy. Moreover, the foreign exchange reserve that is used to import gold reduces
the availability of this resource to finance the import of other commodities. Such high value of gold imports has
now started hurting India’s current account position.

Gold’s share in total import bill of the country has gone up from 8.2 % in 2001-02 to 10.9 % in 2010-11. The
percentage share of gold and silver combined has risen from the 3rd most imported commodity in 2000-01 to
the 2nd most imported commodity in 2010-11 behind only crude oil.

Whereas comparatively the import share of other key industrial raw materials such as Coal, Coke, Iron and Steel
is much lower in the total import bill of the country (Table 1):

2 Gold impact on Indian Economy

Swapnil Soni, Department of Management Studies, IISc Bangalore
 Table 1: Top Ten Import Commodities – India
(Percentage Share)
2000-01 2010-11
Commodity Share Commodity Share
Petroleum, Crude and Products 31 Petroleum, Crude and Products 30.1
Pearls, Precious and Semi-Precious Stones 9.5 Pearls, Precious and Semi-Precious Stones 8.9
Gold and Silver 9.2 Gold and Silver 10.1
Electronic Goods 6.9 Electronic Goods 6.1
Machinery except Electrical and Electronic 5.4 Machinery except Electrical and 6.6
Electronic
Organic and Inorganic Chemicals 4.8 Organic and Inorganic Chemicals 4.2
Source: World Gold Council

Gold utility in India:

In India major usage of gold is in Jewellery (43%), followed by Investment (35%), Technology (12%) and
Central Bank (10%). To suffice these various purposes, demand of gold keeps increasing year by year with
directly correlation with population but hardly correlation with price. Demand and import of gold is also
having influence of excise duty imposed by the government. Following table depicts gradual increase in Gold
import (Table2):

Table 2

Financial Year Gold Import (Bn Rs.) Total (Bn Rs.) Gold Import (% of Total Import)
2000-01 188.29 2308.73 8.2%
2001-02 198.89 2452.00 8.1%
2002-03 186.08 2972.06 6.3%
2003-04 299.46 3591.08 8.3%
2004-05 473.48 5010.65 9.4%
2005-06 479.51 6604.09 7.3%
2006-07 654.40 8405.06 7.8%
2007-08 673.30 10123.12 6.7%
2008-09 953.24 13744.36 6.9%
2009-10 1358.78 13637.36 10.0%
2010-11 1847.42 16834.67 10.97%
2011-12 2699.01 23454.63 11.5%
2012-13 2921.49 26731.13 10.9%
Source: RBI

B. Evolution of Gold Policy in India

As discussed above the vital role of gold in Indian economy and society, there has been remarkable dynamics in
Indian economy because of import, trade and possession of gold by households and commercial entities. In
order to rein the gold trade and make economy ‘gold proof’ government had to intervene with Gold Policies.
The conceptualization and evolution of these Gold control policies are discussed as follows in sequence:

(1) Pre Liberalization

Until economic reforms in the early 1990s, the gold policy centred around the major objectives of discouraging
people from purchasing gold, reducing domestic demand, regulating supply of gold, curbing smuggling and
black income and conserving foreign exchange.

Some important characteristics of the gold policy that had been adopted over the years by the government until
the liberalization process were:

3 Gold impact on Indian Economy

Swapnil Soni, Department of Management Studies, IISc Bangalore
1. Foreign Exchange Regulation Act (Jan, 1974) :
 Ban of import or export of bullion.
 The proportional reserve system was replaced by the minimum reserve system, for purposes of note
issue.
2. Issue of 15-year Gold Bonds at 6.5% (Nov, 1962):
 In a major effort to mobilise the vast gold reserves in the country, the Government issued 15-year gold
bonds at 6.5% in exchange for gold, gold coin, and gold ornaments.
 Subscriptions to these bonds totalled 16.30 tonnes.
 Forward trading in gold was banned in November 1962.
3. Gold Control Rules (Jan, 1963):
 Prohibition of manufacturing of gold ornaments of more than 14 carat purity.
 Compulsory declaration of individual gold holdings.
 The Government thus established full control over the internal trade and distribution of gold by 1964.
4. Issue of 15-year Gold Bonds at 7% (Mar, 1965):
 A second attempt to convert unaccounted money bonds.
 The quantity raised was 6.1 tonnes.
5. National Defence Gold Bonds for 15 years at 6.5% (Oct,1965) :
 Unlike the earlier two issues, which were repayable in Rupees (the value of gold being calculated at
international prices) these bonds were redeemable in gold of standard purity at maturity.
 The quantity raised was 13.7 tonnes.
6. Amendment of rules (Nov, 1966) :
 Ban on the manufacture of ornaments of more than 14 carat purity was removed.
 Placed ceilings on individual holdings.
 Extended control over refineries and dealers.
7. Gold (Control) Act (Sept, 1968), Mr Morarji Desai :
 Established the scheme of gold control on a permanent statutory footing.
 The Voluntary Disclosure of Income and Wealth (Amendment) Ordinance, 1975 granted immunity
from confiscation, penalty and prosecution under the Gold Control Act, 1968, to all disclosures of wealth
and income in the form of gold within the stipulated period.
 Goldsmiths could not own more than 100g of gold.
 Dealers could own maximum of 2Kg gold.
 No manufacture of gold in form of bars and coins.
 This act was made with the intention of curbing foreign exchange, rather it lead to increase in
smuggling of gold.
8. Shift in Central Government policy (Budget,1978-79) :
 Smuggling operations were considered to be a consequence of the differential between the domestic
and international gold prices.
 The Government undertook gold auctions as an anti-inflationary measure of raising resources to bridge
the budget deficit which then was around Rs.1,050 crore.
4 Gold impact on Indian Economy
Swapnil Soni, Department of Management Studies, IISc Bangalore
  The Reserve Bank of India was chosen as the Government’s agent in the sales operation as it was also
felt that sale of gold from stocks held by the Government would curb smuggling to some extent.
 Auctions were criticised saying that they were not a practical proposition to either check smuggling or
contain domestic prices.
 The Government thus discontinued the official auctions in October 1978.

(2) Post Liberalization

During the early nineties a period when the Indian economy faced a severe Balance of payment crisis there has
been a shift in the approach of the gold policy. Restrictive policies made way for a more liberalised gold market.
That the role of a liberalized and developed gold market was in the interest of consumers had been realised and
efforts were made to integrate the gold market with financial markets.
1. Amendment to RBI act (1990) :
 Marking gold to market at regular intervals.
 Gold control Act (1968) was repealed.
2. In 1993 provisions of FERA (1974) repealed.
 To welcome foreign investor FERA turned into FEMA (Foreign Exchange Management Act).
3. Establishment of committee on Capital Account Convertibility (CCA) by RBI (1997):
Observations of this committee were:
 Gold related issues to be linked to Capital Account Convertibility
 Liberalizing policy regime on gold
 Develop transparent and well regulated market on Gold
 Introduction of forward trading and gold derivatives in India.
4. In 1999 RBI allowed commercial banks to accept interest bearing gold term deposits against gold

C. Statistical analysis of Gold trade & Indian economy

Having motivated with intensive role of yellow metal in Indian economy statistical analysis is performed based
on macroeconomic data obtained from Reserve Bank of India and World Gold Council. Framework is to
understand the correlation between gold and other macroeconomic indicators to conclude the predictive
mathematical model and analysis. Suitable sample size of economic data is considered based on availability and
feasibility.

Statistical techniques applied:

 Hypothesis testing - for validating the assumptions, hypothesis and claims

 Analysis of Variance- for multiple population comparison
 Regression Model- for predictive modelling
 Correlation analysis- for finding degree of association between dependent and independent variables
 Graphical modelling- for visualizing the framework and intuitions
Table 3: Macro Economic data used for Statistical analysis (sample):

5 Gold impact on Indian Economy

Swapnil Soni, Department of Management Studies, IISc Bangalore
 Foreign
Gold Gold WHOLESA
Petrole Expo Impo Governme Curren
Dema Gold Import CAD LE PRICE Gold Total
Financi Gold Price um Total (Bn rts rts nt cy
nd Import (% of (% of INDEX - (Bn $ (Bn $
al Year (Rs./10g) Import Rs.) (% of (% of Borrowin Assets
(Ton (Bn Rs.) Total GDP) ANNUAL US) US)
(Bn Rs.) GDP) GDP) g (Bn Rs.) (Bn $
ne) Import) AVERAGE
US)
1991-92 4297.63 NA NA 131.27 478.51 NA 6% 9% -3% 384.29 100.0 6 3 9

1992-93 4103.66 NA NA 171.42 633.75 NA 7% 8% 0% 637.87 247.8 6 3 10

1993-94 4531.87 NA NA 180.46 731.01 NA 7% 10% -2% 722.86 112.6 15 4 19

1994-95 4667.24 NA NA 186.13 899.71 NA 8% 10% 0% 756.17 121.6 21 4 25

1995-96 4957.6 NA NA 251.74 1226.78 NA 8% 11% -1% 822.23 127.2 17 5 22

1996-97 5070.71 NA NA 356.29 1389.20 NA 9% 12% -2% 894.28 132.8 22 4 26

1997-98 4347.07 NA NA 303.41 1541.76 NA 9% 13% -1% 948.24 140.7 26 3 29

1998-99 4268.17 NA NA 269.19 1783.32 NA 9% 13% -1% 1042.18 145.3 30 3 32

1999-00 4393.56 NA 179.91 546.49 2152.37 8.4% 8% 11% -1% 1145.31 155.7 35 3 38

2000-01 4473.6 700 188.29 714.97 2308.73 8.2% 8% 12% -1% 1203.21 161.3 40 3 42

2001-02 4579.12 580 198.89 667.70 2452.00 8.1% 10% 13% -1% 1278.86 166.8 51 3 54

2002-03 5332.36 570 186.08 853.67 2972.06 6.3% 9% 12% 1% 1380.23 175.9 72 4 76

2003-04 5718.95 600 299.46 945.20 3591.08 8.3% 11% 13% 1% 1297.27 100.0 107 4 113

2004-05 6145.38 700 473.48 1340.94 5010.65 9.4% 11% 13% 2% 1200.73 187.3 136 5 142

2005-06 6900.56 680 479.51 1946.40 6604.09 7.3% 12% 17% 0% 1277.82 104.5 145 6 152

2006-07 9240.32 780 654.40 2585.72 8405.06 7.8% 13% 19% -1% 1338.00 111.4 192 7 199

2007-08 9995.62 700 673.30 3206.55 10123.12 6.7% 14% 20% -1% 1417.46 116.6 299 10 310

2008-09 12889.74 600 953.24 4199.68 13744.36 6.9% 13% 21% -1% 1446.27 126.0 241 10 252

2009-10 15756.09 933 1358.78 4116.49 13637.36 10.0% 15% 25% -2% 1819.97 130.8 255 18 279

2010-11 19227.08 963 1847.42 4822.82 16834.67 10.9% 13% 22% -3% 1707.22 143.3 274 23 305

2011-12 25722.42 800 2699.01 7430.75 23454.63 11.5% 15% 22% -3% 1903.26 156.1 260 27 294

2012-13 30163.93 864 2921.49 9204.56 26731.13 10.9% 17% 27% -4% 2225.79 167.6 260 26 292

2013-14 30163.93 975 NA NA NA NA 17% 27% -5% 2356.70 NA 276 22 304

Source: Consolidated data from various secondary sources- RBI, WGC, IMF, CII, WB, NSSO

Analysis and inferences

Data from year 1971 to 2012 is collected to observe a pattern and infer the insights out of it.

Assumptions for statistical analysis:

 Financial year wise data is fairly good representation of that year’s monthly and quarterly economic
status.

 Each financial year data is consolidation (central tendency) of entire year’s data that is following
Normal distribution.

 All populations of considered samples are adhering to homoscedasticity property- having same
variances for valid comparison.

 Samples are i.i.d. (identical independent distribution)

Analysis.1: Gold Price & Demand

6 Gold impact on Indian Economy
Swapnil Soni, Department of Management Studies, IISc Bangalore
 Regression Statistics
R Square 0.59102286
Adjusted R Square 0.55694143
Standard Error 94.9203149
Observations 14

Inferences:
1) Gold Price underwent substantially increasing trend
2) After 2008-09 there is surge in rate of increase of Gold price
3) Demand for Gold failed to follow typical Economic fundamental of Supply & Demand theory as there is
hardly any correlation seen between Gold price & Demand
4) Regression analysis witnesses the weak degree of association of Gold price & Demand
5) Existing correlation may exist because of spurious correlation due to Latent variables- Time & Increasing
Population

Analysis.2: Gold Demand & Import

7 Gold impact on Indian Economy

Swapnil Soni, Department of Management Studies, IISc Bangalore
 Correlation Analysis
Gold Demand (Tonne) Gold Import (Bn Rs.)

Gold Demand (Tonne)

1
Gold Import (Bn Rs.)
0.70731856 1

Inferences:

1) There exists a high correlation (70%) between Gold Demand & Import

2) Increase in Demand of Gold (Bars & Jewellery) gives rise to increased Gold Import

Analysis.3: Gold Demand & Import

Correlation Analysis
Petroleu
Gold Government
m Imports (% of CAD (% of
Import Borrowing (Bn WPI
Import GDP) GDP)
(Bn Rs.) Rs.)
(Bn Rs.)

Gold Import (Bn Rs.)

1
Petroleum Import (Bn Rs.)
0.978 1
Imports (% of GDP)
0.847 0.897 1
CAD (% of GDP)
-0.798 -0.808 -0.796 1
Government Borrowing (Bn Rs.)
0.948 0.944 0.871 -0.803 1
WPI
0.122 0.042 -0.214 0.029 0.107 1

8 Gold impact on Indian Economy

Swapnil Soni, Department of Management Studies, IISc Bangalore
Inferences:

Considering last decade (1999-2013) data of various Trade factors and Statistical analysis following can be
observed:

1) Oil (petroleum) & Gold are the two major contributors and have highly positive correlation with overall
country's Import

2) Gold import affects overall trade import highly (84.7% correlation factor)

3) Although Oil is ahead in correlation coefficient with overall Import & Current Account Deficit yet Gold
impacts Govt borrowing more

4) Inflation (WPI/CPI) is more dependent on Gold Import (12%) than on Oil (4.2%)

Analysis.4: Regression Model

Following statistics have been considered for predictive modelling- Multiple Linear Regression model- that will
derive a predictive model for Whose Sale Price Index (measure of inflation) with respect to other economic
factors that are considered independent.
Table 4
Petroleum Government
Gold Import CAD (% of
WPI Import Borrowing (Bn
Financial Year (Bn Rs.) GDP)
(Bn Rs.) Rs.)
Dependent Variable Independent Variables
1999-00 155.7 179.91 546.49 -1% 1145.31
2000-01 161.3 188.29 714.97 -1% 1203.21
2001-02 166.8 198.89 667.70 -1% 1278.86
2002-03 175.9 186.08 853.67 1% 1380.23
2003-04 100.0 299.46 945.20 1% 1297.27
2004-05 187.3 473.48 1340.94 2% 1200.73
2005-06 104.5 479.51 1946.40 0% 1277.82
2006-07 111.4 654.40 2585.72 -1% 1338.00
2007-08 116.6 673.30 3206.55 -1% 1417.46
2008-09 126.0 953.24 4199.68 -1% 1446.27
2009-10 130.8 1358.78 4116.49 -2% 1819.97
2010-11 143.3 1847.42 4822.82 -3% 1707.22
2011-12 156.1 2699.01 7430.75 -3% 1903.26
2012-13 167.6 2921.49 9204.56 -4% 2225.79

Results:

Regression Statistics
Multiple R 0.652103
R Square 0.425239
Adjusted R Square 0.066013
Standard Error 27.27426
Observations 14

9 Gold impact on Indian Economy

Swapnil Soni, Department of Management Studies, IISc Bangalore
 ANOVA
Significanc
df SS MS F eF
Regression 5 4402.925 880.5851 1.183765 0.3952871
Residual 8 5951.083 743.8853
Total 13 10354.01

Coefficient Standard Upper Lower Upper

s Error t Stat P-value Lower 95% 95% 95.0% 95.0%
Intercept 147.6413 94.1242 1.5686 0.1554 -69.4093 364.6920 -69.4093 364.6920
Gold Import
(Bn Rs.) 0.0156 0.0466 0.3351 0.7462 -0.0918 0.1230 -0.0918 0.1230
Petroleum
Import (Bn
Rs.) -0.0003 0.0173 -0.0190 0.9853 -0.0403 0.0397 -0.0403 0.0397
CAD (% of -
GDP) 26.8286 800.0212 0.0335 0.9741 -1818.0236 1871.6808 1818.0236 1871.6808
Government
Borrowing
(Bn Rs.) 0.0703 0.0819 0.8585 0.4156 -0.1185 0.2591 -0.1185 0.2591

Inference

1) WPI is still having a positive correlation with Gold Import even in presence of other economic factors

2) As gold import increase WPI (inflation) will also tend to increase this will affect the entire Indian
economy

3) Based on above findings following Multiple Liner Regression Model can be derived

Regression Model
WPI = 147.6 + .016*GI + 26.8*CAD + 0.07*GB

WPI Whole Sale Price Index

GI Gold Import (Bn Rs)
CAD Current Account Deficit (% of GDP)
GB Government Borrowing (Bn Rs.)

D. Recommendations

Looking at the presented scenario it is required to address the larger issue which is to encourage the substitution
gold purchases with alternate investment options available in the financial sector which shall also help in
increasing the productive capacity of the economy. In order to achieve this objective some of the initiatives that
can be taken are:

1. Increase the reach of Banks - growing demand for gold purchases in the country is an indication that
households with high levels of savings are looking at options available to invest their savings. As per a World
Gold Council Report5 India has one of the highest saving rates in the world; estimated at around 30 percent of
total income, of which 10 percent is invested in gold. Therefore it is important that the financial sector taps into
this huge saving reserve.

10 Gold impact on Indian Economy

Swapnil Soni, Department of Management Studies, IISc Bangalore
This is particularly true for the rural areas where according to the same World Gold Council Report only 21
percent of rural India had access to formal financial sources. Therefore lack of availability of alternate avenues
of investment that might be resulting in heavy gold purchases.

2. Innovative means of alternate investments must be considered - It must be understood that it is easier for
a rural person to buy gold jewellery than opening a deposit account in a bank, due to various documentary
formalities that are required. In the competitive environment, banks have to contend with the transaction cost
associated with servicing retail deposits and credit accounts. The government can make use of its vast network
of post offices in order to delivering financial services to the otherwise excluded sections. 24

3. Liquidity quotient of alternate investment instruments - a prime reason behind increased gold purchase is
its liquidity aspect that is in case an individual requires money he can immediately sell his gold for cash. This is
usually not the case with other financial products as redeeming them usually takes time. Information technology
could play an important role in facilitating retail banking in rural areas. However, in rural areas low level of
technology penetration coupled with low levels of literacy are a major obstacle for enhancing the outreach of IT
enabled banking services. In this context, there is a need to recognize the role of fiscal empowerment relating to
spending on social sector such as education. The government can also consider introducing highly liquid across
the counter instruments with the government guaranteeing buybacks.

4. Massive education campaign must be launched – to create awareness amongst the public at large as to how
unnecessary piling of gold stocks with households is not only adversely impacting the current account position
of the economy but also what it is doing is increasing the level of black money circulation in the economy. This
is happening because the purchase and sale of gold is being done in cash thereby hurting the government on two
fronts. Firstly, the purchasing gold against cash gives an individual an opportunity to convert his black money
into white. Secondly, the cash received by the seller also remains undeclared and thereby no tax will be paid. On
top of this the gold imports are being financed by the hard earned foreign exchange. Therefore it is imperative
for the government to educate the citizens of the country about the adverse impact of rising gold imports.

11 Gold impact on Indian Economy

Swapnil Soni, Department of Management Studies, IISc Bangalore
References

 Reserve Bank of India- http://dbie.rbi.org.in/DBIE/dbie.rbi?site=statistics

 World Gold Council- www.gold.org
 World Bank- data.worldbank.org
 International Monetary Fund - https://www.imf.org
 Department of Commerce, Government of India - commerce.nic.in
 Ministry of Statistics and Programme Implementation - mospi.nic.in/
 Associated Chamber of Commerce & Industries- www.assocham.org

12 Gold impact on Indian Economy

Swapnil Soni, Department of Management Studies, IISc Bangalore