The demand for gold and its import have been on the rise in India, despite rising gold prices. The RBI has responded by introducing various measures to curb the demand for gold and gold loans. This column discusses the implications of these measures, and suggests complementing such curbs with innovative financial products that can act as substitutes for gold loans.
India is one of the biggest markets for gold and gold loans. According to the World Gold Council, India accounts for 10% of the total gold stock in the world, of which rural India accounts for 65% (2010). Reasons for this are spread across various social, economic and cultural dimensions.
Indians have an emotional attachment with gold because of the traditional value it has come to acquire over centuries. Hence, it is not surprising then that the demand for gold in India is not very responsive to changes in the price of gold. During 2001-2012, the annual demand for gold remained relatively stable at around 700 to 900 tonnes, despite a constant rise in the price of gold (RBI 2013). Increasing inflation lack of alternative financial products and perception of gold as a safe and highly liquid asset are some of the key economic reasons that have caused the demand for gold to soar even with an increase in prices (RBI 2013).
Soaring demand, rising imports
With the demand for gold surging high, import for gold too has increased tremendously. At present, it is the second biggest import commodity in India, after oil. India’s gold imports in 2012 were half of the total gold imported globally (World Gold Council). This has been cited as one of the major causes for the increasing current account deficit. In 2012-2013, the total current account deficit was $80 billion, of which gold imports accounted for $60 billion.
Recent government measures to curb gold demand
Looking at Indian consumers’ appetite for the yellow metal, the government has introduced various measures in the past one year to control the demand for gold. Some of the prominent ones are as follows:
- Hiking import duty on gold imports to 15%
- Ruling out provision of credit for gold imports, unless the purpose is to make jewellery for export
- Restricting regional rural banks to provide gold loans
- Loan to value ratio1 not to exceed 60% of the total value of gold
- Restricting lending against gold coins to 50 grams per customer
- Restricting the amount of gold that is imported by banks in a single consignment/ order, such that only genuine needs of exporters of gold jewellery are met
Gold loan market vis-à-vis other sources of credit
In the recent decades, the gold loan market has come to be one of the most reliable sources of credit for low-income households. Compared to other sources of credit available to low-income households - such as loans from Microfinance Institutions (MFI), loans from Self-Help Groups (SHGs), or community-based borrowing - gold loans are easily available with minimal procedural requirements.
In a recent study, I attempt to understand the characteristics and behaviours of the various stakeholders involved in the gold loan market (Sharma 2013). In particular, I undertake a comparative analysis of the organised and unorganised sectors within the gold loan market, by looking at the various motivating factors that may explain the preference of gold loan clients for one or the other sector2, purposes for which gold loans are acquired, and reasons for high gold demand.
For this purpose, 400 randomly selected gold loan clients in Karaikudi town of Sivagangai District, Tamil Nadu were surveyed. The sample was designed such that half of the clients had acquired loans from informal vendors (pawn brokers/ private money lenders) and the other half from formal vendors (banks/ Non-Banking Financial Companies (NBFCs)).
The findings suggest that the average time to receive a gold loan is less than one day, while a loan from an MFI or SHG takes weeks to get processed. The repayment schedule of MFI/ SHG is either weekly or monthly, whereas the repayment schedules for gold loans are extremely flexible. While gold loans can be used for any purpose, 70% of MFI loans have to be used for income generating activities, as per the Micro Finance Institutions (Development and Regulation) Bill, 2011. These consumer friendly features of the gold loan market distinguish it from other sources of credit, thus making gold loan products extremely popular and reliable.
Recommendations for policies pertaining to gold and gold loan markets
However, new policies aiming to reduce demand for gold and curbing gold loan market pose a challenge to the base of the population pyramid. Therefore, it is important to understand the implications of these policies on low-income households. Based on my study, following are a few recommendations pertaining to the gold loan market:
- With an increase in the import duty of gold to 15% and further restrictions levied by the government on the purchase of gold, gold is increasingly becoming unaffordable for the low-income households. Keeping in view the challenge of financial inclusion, discouraging purchase of gold makes the base of population pyramid even more vulnerable to shocks since gold serves as a medium of financial security for low-income households. While the government aims to bring all households under the ambit of the formal financial sector, it should keep in mind that achieving this would take some time, and gold loans would continue to be important during the transition.
- Policy changes in the gold loan sector regulate only formal financial institutions such as banks and NBFCs. This indirectly promotes financial services of informal institutions, and reduces credit options for consumers. Curbing services of formal institutions leads to lesser competition in the gold loan sector. This might increase the cost burden of low-income households as informal service providers could hike the interest rate, decrease the loan to value ratio, or provide low quality customer service. Therefore, the recent policy changes don’t just have an adverse effect on the operation of formal financial institutions, but also on the pricing of the gold loan sector in general.
- Gold is a highly liquid asset and people prefer obtaining gold loans during an emergency situation. My gold loan study also reveals that 31% of the total survey respondents buy gold for use during an emergency. (Sharma 2013) However, restrictions on the purchase of gold imply decrease in the demand for gold, leading to a decrease in gold loans. In the absence of alternative financial products, this leaves low-income households with few credit options.
- Unlike MFI loans, gold loans can be used for various purposes. This provides flexibility to gold loan clients to use the money for medical expenses, education, or repair of household assets etc., which are important investments that improve the quality of life. An added advantage of flexibility in loan use is that it enables us to see the natural expenditure pattern of low-income households. This presents a case for formal financial institutions to develop innovative credit products to meet specific needs (for example, medical expenses, purchase of consumer goods, marriage etc.) that help in building the social capital of low income households. The government’s role too can be pivotal here by introducing schemes that focus not just on enterprise creation but also on improving the quality of life of the poor.
Gold loans in India have been in existence for centuries, in the form of informal institutions such as pawn shops, delivering quick and easy access to loans against gold as collateral. Until a couple of decades ago, gold loans were delivered only through the unorganised sector by private money lenders and pawn brokers. However, with the entry of formal financial institutions in the gold loan sector, the market dynamics have changed completely. Formal financial institutions have introduced innovative gold loan products at cheaper costs, and provide better customer service.
While it is true that high demand for gold increases the current account deficit, the fact that gold is the most valued asset for Indians cannot be ignored. Over the years, gold has become an inseparable part of the Indian society, as it not just holds an emotional value but is also used for various other financial purposes like saving, investment and insurance for times of emergency. Therefore, curbs on the demand for gold and gold loans should be complemented with innovative financial products that can act as substitutes for gold loans. Gold loans are more than just a channel for obtaining credit for the poorest of households in India, and policymakers need to be sensitive to these realities.
This column is based on the findings of a Study titled ‘Study of gold loan market as an alternative source of credit for low-income households’ sponsored by Centre for Micro Finance at IFMR Research.
- In this context, loan to value ratio refers to the amount of loan one can get against gold as collateral.
- Reasons for preference for unorganised sector could be scarcity of organised sector options for consumers, or customers lacking the financial sophistication/ basic literacy to take advantage of the organised sector options; a reason for preference for organised sector may be the high interest rates charged by the unorganised sector.
- Churiwal, Amit and Ashish Shreni (2012), ‘Cognizant 20-20 Insights: Surveying the Indian gold loan market’, Cognizant Business Consulting.(http://www.cognizant.com/InsightsWhitepapers/Surveying-the-Indian-Gold-Loan-Market.pdf)
- Dinesh Unnikrishnan (2013), ‘RBI norms on gold imports may deal a blow to domestic jewellers’, Live Mint, 1 August 2013 (http://www.livemint.com/Money/L1mWy5AwBhYNPE43LPhhLI/RBI-norms-on-gold-imports-may-deal-a-blow-to-domestic-jewell.html)
- Misha Sharma (2013), ‘Why do Indians buy gold?’, Development Outlook, 19 June 2013. (http://www.developmentoutlook.org/2013/06/why-do-indians-buy-gold.html)
- Misha Sharma (2013), ‘How do Indians use their gold loans’, Development Outlook, 5 September 2013. (http://www.developmentoutlook.org/2013/09/how-do-indians-use-their-gold-loans.html)
- RBI (2013), ‘Report of the working group to study the issues related to gold imports and gold loans by NBFCs’, January 2013. (http://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/RWGS02012013.pdf)
- ‘RBI restricts bank lending against gold’, Live Mint, 27 May 2013 (http://www.livemint.com/Politics/tSyb5MXFxnnrIt66NKZO5J/RBI-restricts-banks-lending-against-gold.html)