Why not Gold Bonds

Sub Heading: India needs to do what Roosevelt did in 1933 and bring Gold Bonds rather than India Bonds in its hunger for dollars

Behind every symptom, there is a disease. And behind disease, like, say, cardiac complications, there is a cause, which is either embedded in the DNA or picked up by choice—be it smoking, or excessive drinking and eating. The drastic fall in the price of the rupee in relation to the US dollar, as we are witnessing now, is a symptom. The disease has been diagnosed by experts as current account deficit, which is the gap between what we earn in dollars by way of goods, services and transfers, and what we pay under these heads, again by dollar. But the current account deficit, or CAD, though still high, is responding to controls. From a scary 7 per cent of the GDP last year, it is poised to settle for 4.5 per cent by March next. So what exactly is the disease?

The Economist magazine has, in an article in its current issue, identified it as the changing nature, not the amount, of external borrowing of which the present ratio in GDP is none too high, about 21 per cent. But, as the magazine says, “it has become more short term, and therefore riskier”. The Economist calculates that India’s financing needs for rolling over of foreign debt and meeting import bills will be US $250 billion by the end of this financial year, against a foreign exchange reserve of US $279 billion. That gives a ‘coverage ratio’ of 1.1 which has dropped sharply from nearly 3.3 times in 2008. This is the reason why private firms that owe most of government debts are a worried lot as many of them will go bust if the rupee falls further. And, apprehending that it will indeed fall, private equity investors are selling off whenever possible and are resolutely staying away from fresh investments. On the other hand, private domestic savers are putting most of their savings into purchase of gold only. Nobody has investment on mind. Now comes identifying the etiology of the disease, or identifying its cause. It was a passionate belief in the 2004-08 years that foreign inflow would arrive on its own, which led to laxity in raising domestic investment capital. This complacency has led to the present shortage of dollar, and so the exchange rate of the rupee has crashed.

Finance Minister P. Chidambaram and outgoing RBI Governor Dubburi Subbarao have tried out both short term and long term measures, though nothing has been fruitful. But the elephant in the room they have so far ignored is India’s gigantic gold stock, amounting to 18,000 ton above the ground, by a World Gold Council calculation. Historically, perhaps due to repeated foreign invasion, and the lack of patriotic spirit to resist it, Indians became worshippers of gold as the asset they could hold, hide, liquidate or mortgage. Gold in private hands is a national waste, but it is a great help to beleaguered exchequer. Following the Great Depression, US President Franklin Roosevelt issued an order in 1933 banning holding of gold privately. Initially the compensation offered was below market rate; it became just the market rate after a lot of lobbying. Non-compliance of the order carried tough punishment, of a $10,000 fine (a dollar in 1933 is $16.83 by today’s cost of living index) or 10 years’ imprisonment. Roosevelt put the confiscated gold into Federal Reserve, the US central bank, and could inflate the economy. It was a successful government measure to save the economy.

India experimented with something similar after the Chinese aggression of 1962, when foreign exchange drained out (to buy armaments), and Morarji Desai, the upright finance minister, came out with the Gold Control Act of 1962, and later banned fabrication of all gold jewelry above 14 carat. In 1968, he came up with a still more rigorous law prohibiting citizens from owning gold as bars and coins, and making declaration of gold jewelry compulsory. But India’s response to Morarji’s efforts was the exact opposite of that of the American public to Roosevelt’s call. Indians’ hunger for gold intensified even more, and is still rising. Why?

It could be because Americans had bought gold with legitimate money and so there was no fear of being heckled by the tax department. In India, the gold bond scheme that Morarji launched in 1965 not only gave tax immunity but offered a 6.5 per cent interest to cover the difference price of the yellow metal in India and abroad. Yet it fell flat on a disbelieving public.

I think the present government should revisit the past and find out what exactly caused Morarji’s gold bond to scupper. It is possible that the banking system was too small in those days, and there was no secondary market where the bonds could be traded. Besides, there was no assurance that the underlying gold asset would be returned to the depositor at a future date.

But the government today can correct Morarji’s lapses. It can issue 10-year gold bonds at a consumer price indexed inflation rate, guaranteeing return of the gold on maturity, and making redemption very costly before the redemption period. As we know from history, Morarji was too stubborn an administrator, nor was he in a position to make a national appeal as he did not enjoy the best of relations with either the prime minister, Lal Bahadur Shastri, or the upcoming leader, Indira Gandhi.

However, leaving politics behind, the present generation of India’s leaders must obtain at least a quarter of the gold hoard. Even this slice is worth US $200 billion. It can instantly stanch the tide of dollar outflow, and bring the rupee back to its 2010 level of 50 and above. That brings India back into the race. From then on, if it stops violating the rules of the game, such as burning money to buy votes, and being squeamish about land for industry, it may again become an emerging giant, and not a submerging economy.

(Harish Gupta is National Editor of the Lokmat group based in Delhi)