Gold: consumption or investment -V.P.Nandakumar

With India’s Current Account Deficit now a cause for serious concern, everyone has woken up to the fact that our import of gold is next only to petroleum in terms of forex outgo. Our obsession with gold is jeopardizing our macro-economic stability, say our policy makers. There’s one school of thought that believes gold imports should not be reckoned in the current account at all. The argument is that people buy gold as investment, and therefore it should be accounted for in the capital account. Not that a reclassification of this kind would have any impact on our final balance of payments, but it would  certainly make the current account look a lot better. And sometimes, perception can matter more than the underlying reality.
When deciding whether buying gold amounts to consumption or investment, a conventional way out is to look at the form in which it bought. When purchased in the form of bars, coins and biscuits, gold is investment and when bought as jewellery, it is consumption. However, careful thought suggests that even when gold is bought as jewellery it has characteristics of both investment and consumption.
To understand why, we need to step back a little and look at how India’s fascination for gold has evolved historically. India is the largest consumer of gold in the world. Our love affair with the metal is age old.  Roughly 800 to 900 tonnes, or about a third of the total gold mined in the world, is consumed in India. Domestic production being negligible, we are the largest importer of gold.
The Indian attachment to gold is a product of our history. Gold is rare and beautiful and stable. It does not depreciate in value nor does it deteriorate in quality with time. It is compact and can be carried around with ease. It can be buried underground without loss of quality or quantity. Gold is therefore permanent, portable and hideable wealth. And because it can be easily concealed, it is more resistant to expropriation. In the olden days, when property rights were not secure and not always respected — being subject to arbitrary seizures by kings, courtiers and warlords or prone to destruction during frequent wars etc.— gold was the most sensible way to accumulate wealth. Along the way, it became part of our culture and tradition. It acquired a social, emotional and economic significance beyond logical comprehension. Many of our traditions have changed over the years, but large scale purchases of gold during weddings continue. The newer generation may be less inclined to flaunt it, but demand for gold jewellery shows no signs of abating.
From the point of view of an economist, gold cannot be considered as investment because it is unproductive by nature. It does nothing but sit idle in safes or bank vaults. Other financial instruments like fixed deposits with banks, shares, bonds, insurance policies etc. are a source of productive funds for business and government, and have a positive impact on economic activity.
From the point of view of the individual, an important reason for buying gold jewellery is the satisfaction you or your loved ones get from wearing gold jewellery. In this sense, gold plays the role of consumption because you get satisfaction from its usage. However, strictly speaking, for something to be consumed, the process of consumption should also lead to a decrease in the useful life of the product. It should result in a gradual destruction of the product over the years as happens, say, to a motor car used for many years. But as we have already noted, gold is not subject to depreciation. When you wear jewellery over a long period its physical qualities remain intact. (There is some wear and tear, but not significant.)
The other important motivation for buying jewellery, common to all investments, is the conviction that the gold will hold its value over the long term, even after adjusting for inflation. It is therefore no accident that if India’s gold consumption has surged in recent years, it happened in lockstep with the resurfacing of inflation in the economy. Prices have risen sharply and interest rates on bank deposits have failed to keep pace. The common man responded in the most logical way. He moved his money away from bank deposits and into gold. It helped his cause that till recently gold enjoyed an unprecedented bull run of its own.
Seen in this light, gold in the form of jewellery is wearable investment. There is pleasure in wearing it and there is also a reasonable expectation that it will appreciate in value. It is both similar to, and different from, a work of art. With art we get satisfaction from the mere viewing, along with a reasonable expectation that its value will appreciate over time. But the difference is that when you drop it, break it, or splash paint over it, art loses its value… unlike gold jewellery.
V.P.Nandakumar

MD&CEO of Manappuram Finance Ltd