Cutting the trade deficit means cutting India's gold demand. How...?

 

INDIA's prime minister Narendra Modi wants to get his hands on the gold in the country's temples, writes Jeff Clark at Casey Research.

 

There's estimated to be approximately 3,000 tonnes, more than two-thirds the amount held at Fort Knox. Modi wants it to combat the country's chronic trade imbalance.

 

He plans to launch a program next month that would "encourage" temples to deposit their gold with banks, in return for interest payments. The government would then melt the gold and loan it to jewelers. The thinking is that this would reduce gold imports, and thus the trade deficit. Gold accounted for 28% of India's deficit last year.

 

If successful, gold prices could come under pressure. India represented 17% of total global gold demand last year.

 

So, will it work?

 

India's love affair with gold spans centuries. It's rooted in their religion. Marriage dowries that include gold are widespread. About 70% of the population – which holds perhaps 17,000 tonnes (550 million ounces) of gold in jewelry and other heirlooms – is distrustful of government and would have to hand over gold that's been passed down through generations. Giving it to the government would go against their traditions and instincts.

 

It was tried before and for the most part was unsuccessful. A "gold monetization plan" was offered in 1999, and the State Bank of India offered 0.75% to 1% on deposits. Fifteen years later, a total of only 15 tonnes of gold has been deposited.

 

However, if the new plan offered substantially higher interest rates – say, 5% – it would definitely entice some investors. Some have already stated they would consider participating if rates were that high.

 

The scheme could backfire on the government. What if gold prices shoot higher and depositors want to withdraw their gold? The government will probably have a "lock-in" period where withdrawals couldn't be made, but that lock-in period couldn't be "forever". And the greater the withdrawal requests, the more gold Indian banks would have to buy to replenish the metal, spurring demand.

 

We'll keep an eye on this development, but given the strong tradition Indians have for gold, odds are the overall impact will be small.