Is India’s Love For Gold Hurting The Equity Markets?

At the start of this week, managing director of Kotak Mahindra Bank, Uday Kotak tweeted that India's net gold and stones imports between the financial years 2011 and 2019 were $245 billion while net FPI (foreign portfolio investor) inflows into debt and equity were $145 billion.

"Hence we net exported $100bn domestic savings into gold etc while foreign savers bought into our top companies. FPIs generally avoid small and mid caps. A good trade for India?"

Some facts: fy 2011 to 2019. Net gold and stones imports 5bn. Net FPI inflows debt & equity 5bn. Hence we net exported 0bn domestic savings into gold etc while foreign savers bought into our top companies.FPIs generally avoid small and mid caps. A good trade for India?

— Uday Kotak (@udaykotak) September 2, 2019

His tweet did bring into focus the undying love for gold among Indians who look to averse risk and how this practice may have been hurting the country's economy.

It is in the tradition

Traditionally, Indians have always believed in investing in physical assets like real estate and gold. Every year, gold and precious stones are purchased as a ritual to save for the future.

Further, despite an increase in the number of investments that allow one to put money on market-traded instruments, a majority of small Indian investors do not want to risk it. They would prefer to invest it in fixed deposits, gold or real estate, things are simpler to understand.

One cannot blame a common person in India for such behaviour. Gullible investors have fallen into traps of Ponzi schemes that promise higher returns, only to lose their hard-earned money.

Awareness of safe investment schemes like mutual funds is limited to a fraction of India's population.

How has increased purchase of gold hurt India?

India depends on imports for most of its domestic supply of gold and precious metals. When the extent of purchase of the precious metal goes up, our imports increase.

Further, as Uday Kotak pointed out, money from the domestic scene is flowing out of India as we import gold in US dollars.

Also, as less number of domestic investors put money on equities of Indian companies, the markets are becoming dependent on foreign investors, creating higher volatility as they can choose to withdraw at any time if they find another country's market that appears more "hot" for the moment. We have seen this occur in the Indian markets in July when the withdrawal of FPIs after an increase in surcharge lead to an exodus that caused a bloodbath in the equity indices.

Indian companies depend on the equity investors for a good portion of their capital supply. When capital falls short, they cannot run their businesses as efficiently and are also not able to reward their investors for putting faith in them.

Another point to observe is that FPIs usually put money on large established companies and not the small or mid-caps. Small establishments make for a large portion of a total number of India's businesses that create jobs and are a major contributor to the economy.

Indian companies could benefit greatly if more and more of its own citizens would put funds in their stocks. If the portion of domestic investors rose, then the markets would not be as affected by FPI investors or their withdrawals and this would reduce the volatility.

Gold imports also hurt trade deficit

It is one of the basic rules of economics that when imports are higher than exports, it causes a trade deficit, which is not good for any country.

Gold. Best financial returns 1 year. But unproductive asset. We Indians love it and export domestic savings to import gold. Country runs current account deficit. Huge gold stock with individuals, temples. Time for new gold policy. Recirculate local gold and reduce imports asap.

— Uday Kotak (@udaykotak) September 1, 2019

Can this change?

While it is very difficult to change the state of minds of millions in India who are conditioned to believe that gold is the only real form of wealth, increased awareness and understanding of how the stock markets works and how their investment can help grow the country's companies and its economy could help.

Apart from the government's efforts, companies can also instil this faith in investors by bringing more transparency in their functioning. While equity investments are encouraged, if you choose to invest in them yourself, (rather than through an asset management company's mutual fund) you should be keen of the company's management and its business aspects before you bet on any company.