THE yellow metal has for centuries fascinated Indians, who have been buying and stockpiling gold across generations. Irrespective of socio-economic or geographic barriers, Indians have had a passion for gold, which for millions of people is the only investment instrument.

While the vast majority of Indians still do not invest in stocks or corporate debt, and a substantial portion of the population does not avail banking services, gold is the most solid investment tool for millions. Buying gold on festive occasions, for weddings and other social events, has become ingrained in the psyche of the rich and the middle-classes as well as the poor.

Unfortunately for a nation whose billion-plus population is so much in love with the yellow metal, India produces a negligible quantity of gold. Last year, the country produced just about 2,200 kgs of gold. In August this year, production was pegged at 123 kgs. Karnataka, where the Kolar Gold Fields are located, is the only major producer of the metal.

Considering the enormous demand for gold and the marginal domestic production, India has been a huge importer of the metal. But it was only after the economic reforms of 1991 that the government opened up gold imports. For most of the post-Independence years, restrictive laws banning gold imports resulted in a thriving smuggling business that spawned dozens of crime syndicates in Mumbai and other coastal cities.

It was after the 1962 Indo-China war that the government enacted the Gold Control Act, to preserve foreign exchange, prohibiting citizens from holding pure gold bars and coins. The legislation virtually decimated the gold trade, but resulted in a thriving smuggling business.

Hundreds of kilos of the precious metal would be brought in fishing boats and other small vessels and off-loaded along the western coast, from where the stuff would be distributed all over the country. Later, in the 1970s and 1980s, as millions of Indians began working and living abroad, many of them would bring back some gold ornaments as personal belongings.

In 1990, when the country faced a major economic and foreign exchange crisis, the government pledged 40 tonnes of gold from its reserves to the Bank of England to access hard currencies to pay for its imports including oil and petroleum products. The crisis led to some soul-searching and forced the government, then led by P.V. Narasimha Rao, the Congress prime minister, to initiate dramatic economic reforms. Manmohan Singh, the UPA’s prime minister since 2004, who was then a bureaucrat (and the governor of the Reserve Bank of India), was brought in as finance minister by Rao, to launch radical reforms measures.

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WITH the dismantling of the licensing raj, the government also scrapped the Gold Control Act and imports were allowed from 1992, when about 110 tonnes of the yellow metal were brought in. Last year, imports peaked at a record nearly thousand tonnes, making India the biggest buyer of the metal, even ahead of China.

Gold imports, however, have been straining the country’s finances—along with the import of petroleum products—forcing the government to take counter-measures. Last fiscal, India imported about a thousand tonnes of gold at a cost of $60 billion, widening the current account deficit (CAD) to a record 4.2 per cent of the GDP. Gold imports accounted for 75 per cent of the CAD.

Worried about the growing deficit, the government decided to raise the import duty on gold to two per cent in January and later doubled it to four per cent in March. Gold prices also soared for much of 2012, a year when the Indian rupee also lost against the dollar. All these factors contributed significantly to a sharp decline in imports.

Mohit Kamboj, president, Bombay Bullion Association, believes this financial year (April 2012-March 2013) imports could be down by 45 per cent. The World Gold Council (WGC) estimates a 20 per cent fall in gold imports in calendar year 2012 to 800 tonnes. Amresh Acharya, director, investments, WGC, pegs gold demand at 600 tonnes for the first three quarters of 2012 (January-September).

During the April-June quarter, gold demand plunged by 38 per cent (over the corresponding quarter last year) to 181 tonnes. But the July-September quarter saw a revival, with a nine per cent growth in demand, says the WGC.

According to Marcus Grubb, managing director, investment, WGC, the Indian market is showing signs of recovery following increase in both jewellery and investment demand. Indians appear to have acclimatised to recent price trends and have been buying into a rising market, he says.

Importantly, after the global economic crisis of 2008, gold is beginning to re-establish itself as part of the fabric of the financial system, he says. “In the medium term, the quantitative easing initiatives in the West and the continuing growth story in the East, particularly in India and China, coupled with the seasonally strong quarter coming up in Asia, are excellent indicators for further growth in the gold market.”

International gold prices have shot up by more than 10 per cent this year and the rupee has also lost nearly 15 per cent, making the yellow metal even more precious for buyers in India.

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ESTIMATES about the extent of gold reserves in India range from 20,000 tonnes (by the WGC) to as high as 25,000 tonnes by other sources. Even at 20,000 tonnes, it adds up to a hefty $1.16 trillion in reserves

Last week, Subir Gokarn, deputy governor, Reserve Bank of India, warned that the country’s gold imports could add up to two per cent of the GDP over the next few years. Gokarn called for alternative instruments with ‘gold-like qualities.’

“People are buying gold despite the high price,” he remarked. “This, in some ways, challenges the supply-demand dynamics. India imports about one-fourth of the total global supply of a little over 4,000 tonnes, and this excess gold demand is creating stress on the system, particularly on the balance of payments.”

Of course, Gokarn admits that despite rising prices, gold acts as a hedge against inflation and provides relatively high returns. “People cannot be denied an opportunity to invest in gold,” he says. “Gold returns have been higher than those of the Nifty, one-year bank deposits
and 10-year-government bonds over the last few years.”

The RBI plans to bring out a draft paper to propose alternative investment instruments including gold-linked accounts, gold-accumulation plans, a modified gold deposit scheme and a gold pension scheme.

Many investors are opting for sophisticated instruments such as exchange-traded funds (ETFs) for gold; gold ETFs have seen a 300 per cent rise in assets in the last two years. Gold ETFs over the last year accounted for 165 tonnes of the yellow metal. Over the last three months alone, about Rs5 billion worth of gold ETFs were bought by investors, according to the Association of Mutual Funds in India.

The Reserve Bank of India, worried about the growing exposure of the financial sector to gold, has also recently cracked down on certain practices. Banks have been asked not to lend against gold, nor offer loans to individuals to buy the yellow metal.

There is, however, a limit to what the government can do. If it raises customs duty on imports further, it could well revive the smuggling syndicates, who have been lying low for several years now after the liberalisation of rules.