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Rajan Says Interest Rates Must Be High and Gold Imports Could Be Investments


In a speech at Harvard Business School, RBI governor Raghuram Rajan tells us a story:

In part, India’s slowdown paradoxically reflects the substantial fiscal and monetary stimulus that its policymakers, like those in all major emerging markets, injected into its economy in the aftermath of the 2008 financial crisis. The resulting growth spurt led to inflation, especially because the world did not slide into a second Great Depression, as was originally feared. So monetary policy has had to be tight, with high interest rates contributing to slowing investment and consumption.

This is the first time I’ve heard of the RBI admitting to inflation through loose monetary policy. And I welcome the resulting tightness, though it would be strange to say it’s enough today.

And he makes an interesting point:

An increase in gold imports placed further pressure on the current-account balance. Newly rich consumers in rural areas increasingly put their savings in gold, a familiar store of value, while wealthy urban consumers, worried about inflation, also turned to buying gold. Ironically, had they bought Apple shares, rather than a commodity (no matter how fungible, liquid, and investible it is), their purchases would have been treated as a foreign investment rather than as adding to the external deficit.

This is important. The fact that Gold comes part of our current account deficit is because we categorize it that way. Gold is not used for things – it’s largely stored as an investment. If people bought Apple shares – or indeed anything like shares abroad – it would come into the capital account, not the current account.

Effectively when you invest abroad, you have a cash outflow but what you own can be sold in dollars, so that impact could be removed to see how much the real “consumed” imports are. However, gold muddies the waters. Gold isn’t sold back internationally – and if it is, the price will fall hugely, because Indians consume more than 50% of gold sold worldwide. And then, we don’t just import gold, we import jewellery, which will have a much lower buy-back price. So to just remove gold imports would be to deny reality that the reverse transaction is simply not going to happen, and the deficit will have to be bridged anyhow.

The accounting of gold, however, can bring the current account deficit down substantially. We have to follow world standards today, but it would be interesting to see what the “external deficit” would look like minus gold.

Still, there’s a whole lot of Gold in the country, and the only way to bring it out is related to the first point – I say bring down inflation to 3% or less, and watch people lose interest in Gold.


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