In gold, we trust

Recently, two headlines grabbed my attention, both circling India’s complex economic relationship with gold:

First, Tamil Nadu Chief Minister MK Stalin publicly challenged the RBI’s new guidelines on gold loans. It’s unusual for a chief minister to directly question RBI policies, highlighting just how deeply gold loans are woven into the financial fabric of Indian households.

Second, a striking revision happened a few months earlier: India’s current account deficit numbers for November were suddenly corrected from $37.8 billion down to $32.8 billion, a 15 per cent drop. The reason? An accounting mistake involving gold imports, initially reported at $14.8 billion, was later revised down to $9.8 billion. Even after correction, gold imports astonishingly accounted for nearly one-third of the deficit.

As you may know, the current account deficit (CAD) is one of those macroeconomic vital signs that economists obsess over. It influences everything from the strength of the rupee to how much mutual funds can invest in overseas markets. It prompts governments to impose taxes on foreign remittances above ₹7 lakh—the kind of detail that starts off as a dull footnote but ends up adding 20 per cent to your holiday plans.

A shiny problem
While most countries regard gold as little more than a shiny trinket in their trade stats, India has a very special relationship with the precious metal. On average, Indians buy 0.6 g of gold per person annually—three times the global average of 0.2 g. Of the $10.7 trillion in total household assets across India, a staggering 15 per cent sits in gold, which is three times what’s held in equities. By contrast, other nations typically keep just 2–3 per cent of household wealth in gold.

Why is this significant? In macroeconomic terms, gold is what you might call a “dead asset.” It neither creates an investment multiplier nor a credit multiplier in the economy. Investing ₹1 crore into a company’s equity can spark a virtuous cycle: the company can use the money to build factories, create jobs, and stimulate greater productivity. Similarly, ₹1 crore invested in a bank FD leads to multiples of that amount being lent to borrowers who could use that capital for productive purposes. However, sinking ₹1 crore into gold mostly just sits there. It’s the economic equivalent of burying treasure in your backyard rather than planting seeds.

Roots of India’s gold preference
So, yes, the CAD is just the tip of an enormous, glittering iceberg. The question is: Why does India love gold so much? Part of the answer is cultural. India’s love affair with gold is deeply rooted in tradition. Gold is metaphorically woven into the fabric of our daily lives and woven into the zari in a Banarasi sari and the kara of a Malayali mundu - rather literally. When my daughter was born, my mother performed a ritual that involved grinding a bit of gold into dust, mixing it with honey, and giving my infant her first taste of something other than milk.

It’s a tradition that’s common not just in our community but to many others. Gold is also the traditional means by which intergenerational transfers are made to daughters, usually at the time of marriage: the Indian wedding jewellery market alone is a jaw-dropping $40 billion behemoth.

All this said, a cultural preference for gold is hardly unique to India. What then explains the overwhelming preference for gold in India?

When one dives deeper, they realises that while India has an overdeveloped gold lending market on one end (with gold loan AUMs in India amounting to nearly ₹150 billion, or 3.5 per cent of GDP) and an underdeveloped mortgage market on the other. Economic growth stories in places like South Korea depended on the credit creation that the growth of the mortgage industry provided. Today the mortgage-to-GDP ratio in South Korea is close to 57 per cent, and mortgage ratios are sky-high in many OECD countries at 70 per cent -100 per cent.  India’s ratio is much lower, and hovers around 11 per cent. World Bank’s findex survey noted that only 5 per cent of respondents in its sample set in India had an outstanding housing loan, compared to 26 per cent in South Korea.

This is partly because property is far more complex to lend against than gold. Gold is easier to subdivide and use in small quantities as collateral. It is easy to repossess if you are a lender and easier still, to sell (if needed). While the public imagination regarding gold loans has always been that they are a form of distressed debt, for a large part of the economy that operates in cash, gold is a cash flow-smoothing mechanism. Farmers and traders would buy gold when they have excess cash and borrow against the gold when they need cash.

Complicating this further is the fact that land is extraordinarily bad collateral in India compared to other countries. As the Tamil Nadu CM recently pointed out: “Small and marginal farmers often lack formal land titles or verifiable income documentation. For such households, pledging household gold has been a viable and dignified route to access institutional credit”. 

Apart from inadequate land records, India’s famously inept contract enforcement capacity further depletes the value of land as an effective collateral. By all measures, India’s dispute resolution/contract enforcement mechanism is abysmal. There are a whopping 47 million pending cases in the Indian courts. According to the World Bank's Doing Business Report 2020, India ranks 136th out of 190 countries in enforcing contracts. This ranking is significantly lower than China (46th) and Brazil (128th). Additionally, the average time to enforce a contract in India is 1,445 days, which is more than four times longer than the global average of 358 days.

This means that lenders struggle to repossess property collateral in the case of a default. In fact, 66 pr cent of all cases languishing in India’s glacial judicial system are estimated to be linked to land. The resolution of those disputes is not helped by the fact that India’s land records are unreliable to say the least: indeed, India also lacks an addressing standard, making title search and property due diligence much harder. Thus, India has a sub-scale mortgage market on one end, resulting in a super-scale gold lending market on the other end, fueling demand for gold as an effective collateral.

This brings us to a rather ironic situation. With its backlog of land disputes, India's creaky judicial system inadvertently fuels the demand for the yellow metal. Gold, in turn, contributes to the current account deficit, weakening the rupee, which drives the gold price further up in rupee terms, further fueling demand. It's a vicious cycle, a golden vortex that's hard to escape.

Breaking the 'golden' chains
In conclusion, India's golden romance is a complex tale of cultural tradition, economic realities, and systemic inefficiencies. For India to break free from its golden handcuffs and unlock its true economic potential, it will need to find a way to redress its excess dependence on gold as an asset class.

It is hard to think that any economy can become developed (vikisit) without macroeconomic stability in trade accounts and efficient allocation of capital to productive assets. In the Indian context,that will entail a shift away from gold as an asset class and part of that shift is likely to require reforms in domains that are far removed from jewelry and weddings, such as changes in land record systems and improvements in judicial functioning.