Thursday, 5 April 2012

Capital Economics: India's gold lending = gold standard?

All eyes are on the Indian government's attempts to reduce gold imports and tackle a growing trade deficit but with 18,000 tonnes of gold already within it's borders could there be unexpected consequences?

Andrew Kenningham, senior global economist at Capital Economics told Gold ETF Investor that extensive gold lending could result in a commodity-backed currency - a gold standard - but didn't believe this had happened in India yet.

Even if gold imports slow down, any change in the status or use of India's existing gold mountain could be significant. Rajan Venkatesh the managing director of Scotia Mocatta, the largest importer of gold Bullion into India, and the custodian to many of its physical gold ETFs sees these changes as a vital tool to reduce the deficit.

He gave this advice to the Indian government: "To reduce imports, they should instead work on monetizing the existing gold held in households in India, which is estimated at around 18,000 tonnes."

Could this cause a return to a gold standard by the back door?

Andrew Kenningham at Capital Economics told Gold ETF Investor that, in India: "Gold is not widely used as a substitute currency for transactions (as it is in Vietnam for example). Unlike many other developing and emerging economies, India has never had hyperinflation or a major banking crisis, and as a result confidence in the domestic currency (rupee) and banking system is high.

"Gold is however used as a store of value (i.e. for savings) more that it is in many countries. This is partly because the banking system, though it has always been safe, is “repressed” and does not offer good savings rates. In other words the real interest rates are negative, i.e. lower than inflation, because the banks are very restricted as to what they are permitted to invest in. Also banks are very inefficient and bureaucratic, and many poorer households do not have access to bank accounts for various reasons.

Kenningham said: "If gold is used a lot as collateral for loans and deposits in India then that is perhaps similar to a gold standard monetary system in which all money is ultimately backed by a commodity (usually gold or silver). This is not a very widespread practice as far as I am aware. Also, such a practice should be seen in the context of India's huge informal market for loans, operating by informal money-lenders who typically charge very high interest rates. "

In addition to actions taken by the government or suggested by the likes of Scotia Moccatta's Venkatesh, there is a growing gold loan industry. Its largest player Muthoot  Finance, saw its loan value grow by 114% last year.  The firm is believed to make up 19.5% of the gold loan market and at the end of 2011 it had 132 tons of gold backing loans.

The flexibility and interconnectedness of the Indian gold market is evident in the fact that Muthoot  lends against physical gold ETF shares however Muthoot did not respond to questions about the take-up of this product. Nitin Rakesh of Motilal Oswal said: "In principle, it should be a good avenue for both investors and lenders but the data is not very clear as yet."

Rakesh though has pioneered a new gold ETF that allows retail investors to redeem physical gold in 10g bars  which could be seen as another example of how dynamic the Indian gold market is compared to developed markets. It also shows it focuses more on the needs of retail than institutional investors when dealing with gold.

Mineweb reported that Indian gold ETF assets had increased 161% in rupee terms from Feb 2011-Feb 2012.

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