The drivers of Indian gold demand: India gold market series

Qualitative trends and influences

India’s demographic dividend

India is the second most populous country in the world with 1.3 billion (bn) inhabitants.¹² Not only is the population extensive, but its demographic structure is likely to confer significant economic benefits. Unlike many countries around the world, the Indian population is young and expected to remain so for many years. Today, the median age across the country is just 27 and it is forecast to remain below 35 for the next decade (Chart 1).¹³

At the same time, the dependency ratio has been shrinking fast as the working age population (aged between 15 and 64) has grown more rapidly than the dependent population (aged below 15 and above 64). Emerging more than a half a century ago, this trend has become particularly marked over the past 20 years and it is expected to continue in a similar vein until 2040 (Chart 2). As such, the working age population is expected to grow by roughly 7mn per year between 2021 and 2041.¹⁴

This presents major opportunities for India. As research from the Reserve Bank of India indicates, growth in the working age population and participation in the labour force are key determinants of economic growth.¹⁵ This suggests that India is set for a period of strong economic expansion, rising incomes and a growing middle class – all of which are conducive to rising gold demand. 

Regional preferences, population shifts and gold demand  

While India is known for its strong, nationwide affinity for gold, this is especially marked among the rural population, where jewellery ownership is considerably higher than it is in urban areas. Consumption patterns also differ between town and country. Jewellery is considered both an investment and adornment in rural areas. City dwellers tend to consider bars and coins as their preferred forms of investment. 

These differences take on a particular significance for gold demand as Indian cities and rural areas change and evolve.

Increasing urbanisation

India’s population has long been centred around rural communities. But this is in the throes of change. In 1960, just 18% of the population lived in cities. By 2019, that had almost doubled to an estimated 34% and there is every expectation that such a trend will continue through the coming decades (Chart 3).¹⁶ 

Growing urbanisation has already contributed to a significant shift in employment patterns. World Bank data shows that agriculture accounted for 63% of employment in 1991. By 2019, that percentage had shrunk to 43% and it is expected to continue falling sharply – to 25.7% by 2050.¹⁷ Agricultural income has traditionally been both relatively low and relatively volatile. A shift away from this sector should therefore drive incomes higher and, by extension, bolster demand for gold.

In recent times, new products such as Sovereign Gold Bond and digital gold products promoting micro savings have made an impact on savvy urban investors. The advent of bullion banking and exchange traded products may increase the variety of investment products and channels, which may offer potential opportunities for the industry to innovate.

Agriculture- a sector in flux

Falling agricultural employment levels reflect changes to farming’s contribution to the Indian economy. In the 1960s, agriculture was responsible for more than 40% of India’s GDP. By 2019, that had reduced to 16% (Chart 4). Notwithstanding this shift, some 70% of rural households remain dependent on agriculture for their livelihoods.¹⁸

And in recent years, the rural economy has suffered, with annual growth in nominal monthly rural wages averaging just 4.6% from 2014 to 2020 (Chart 5). Adjusted for rural CPI, real wages actually declined, on average falling -0.3% in the wake of persistent weakness in wholesale food prices.

Keen to redress the situation, the government announced a series of measures in 2016, designed to double farmers’ income by 2022. Three specific laws were introduced last year to help farmers still further and policies have been launched to boost non-farming rural incomes too (see Appendix 2 in the full report).

The rural economy – structural change

Encouragingly, the rural economy itself is changing. In 1993, rural areas contributed less than 30% to manufacturing output. By 2011, the time of the last census, that percentage had increased to 51.3%.¹⁹ A continuation of this trend could deliver meaningful change, particularly in conjunction with recent government policies. Online marketplaces and improving infrastructure are changing consumer aspirations and logistical capabilities. This could dilute the sharp division in consuming and investing habits between rural and urban consumers in the coming years. Taken together, they could engender a period of sustained recovery for the rural economy, driving GDP growth and consumer spending across India. 
 
There could also be considerable consequences for India’s gold industry, as rural households still account for a majority of India’s gold demand. Sustained growth in rural incomes may therefore foster demand for gold. 

Indian income levels are rising

Looking back over the past 30 years underlines how far India has come since the economic liberalisation of 1991. Between that time and 2020, India’s economy grew more than ninefold, its foreign exchange reserves soared from US$1bn to more than US$500bn, the middle class expanded and household incomes rose,²⁰ with per capita net income rising from Rs7000 in the early 90s to Rs134,186 per year in FY2019-20.²¹ 

The coronavirus pandemic has provoked a slowdown in economic growth but long-term prospects remain bright, fuelled by these demographic changes, rising urbanisation and shifts in the rural economy. Analysis from consultancy Bain & Company, for instance, suggests that the number of middle-class households should grow by 140mn between 2018 and 2030, while the number of high-income earners will increase by 21mn.²² 

This is likely to presage an almost four-fold increase in consumer spending, from US$1.5tn in 2018 to US$5.7tn by 2030.²³  

Such a shift could have mixed implications for gold demand. As our model shows, rising incomes historically translate into increased gold purchases. Demand will also get a boost as more people move up the economic chain from below the poverty level. At the same time however, today’s consumer is increasingly drawn to other forms of expenditure, a trend that may reduce gold’s share of wallet, if left unchecked. 

Comparatively, however, there is scope to raise gold’s per capita consumption in India, which currently ranges between 0.3g-0.6g per person. This is lower than emerging markets in South East Asia such a Vietnam (0.4g-0.7g) and the Middle East, as well as developed economies such as Germany (1.2g – 2.0g) and Switzerland (3.5g-6g)– where demand thrives alongside sophisticated financial markets.²⁴ But for this to happen, gold has to be positioned with unassailable trust among various other competing savings opportunities and supported by transparent access, integrity and fungibility.

A changing environment for gold as an investment

With India’s deep affinity for gold, Indians have historically turned to this asset as a means of preserving their wealth – and increasing its value over time. Now however, attitudes are changing. Consumer spending on other goods has increased, growing financial inclusion has encouraged more people to put their savings in the bank and greater financial literacy has boosted interest in other assets, such as equities. 

Savings and spending 

India has a long tradition of saving. From the 1960s until 2010, for example, the Indian savings rate climbed from 6% to 34.3%.²⁵ Since that time, however, savings as a percentage of GDP have declined, dipping below 30% in 2018 and continuing to inch lower to this day (Chart 6). Rather than hoarding their money, Indian consumers have begun to spend more on goods and services, such as smartphones, designer clothes and travel. 

Growing financial inclusion  

Even as consumer spending has risen, the government has taken steps to clamp down on unaccounted money and increase financial inclusion. These measures have met with considerable success. Between 2011 and 2017, for example, the share of adults with a bank account more than doubled to 80%.²⁶ 

The growth in micro finance companies and payment banks has helped to boost financial inclusion in villages and small towns.²⁷ At the same time, soaring smartphone use has allowed Indians to access financial services swiftly and efficiently. Many Indian banks now have smart phone apps, access to high-speed internet is inexpensive in many parts of the country and take-up has been enthusiastic.²⁸ As of the end of 2020, India had the second largest number of internet users in the world, with almost 750mn Indians actively accessing the internet each month.²⁹  

Alternative avenues for investment

There has been growing interest in Indian equities too, following several years of strong growth. This is exemplified by the increase in ‘demat’ accounts, used to hold shares and securities in an electronic (or ‘dematerialised’) format. The number of these accounts almost tripled from 16.7mn in 2009 to 49.8mn by the end of 2020 (Chart 7).³⁰  

The amount of money flowing into equities through Systematic Investment Plans (SIP) has also surged in recent years, reflecting growing awareness of mutual fund investment. Average inflows to SIPs more than doubled between 2016 and 2020, from Rs.35bn to Rs.81bn a month (Chart 8).³¹  

Brighter prospects

Financial inclusion and financial literacy, while beneficial for India’s prosperity and income equality, have created challenges for the gold market. These are particularly evident in rural areas, where physical assets, including gold, have long been considered the preferred form of investment. However, bank account penetration has already reached 80% and, looking ahead, the post-pandemic environment may encourage gold ownership, as the economy rebounds, discretionary spending increases and investors seek out assets that will protect their wealth in the years ahead (Focus 1). 

A framework for investment growth 

In an environment where gold faces unprecedented competition as an investment asset, action is almost certainly required. Our latest consumer research has identified three key focus areas, which would allow gold to retain its long-held position as a valued asset across India and an effective investment.³² 

• Trust: Mandatory hallmaking, good delivery standards for gold bars and a gold spot exchange will drive a sea-change in the Indian gold market, building trust among consumers and investors alike 
• Education and awareness: An orchestrated campaign explaining how to buy gold could inspire many potential gold investors, especially if this included products that accommodate small incremental investments. Explaining moves in the gold price, on television for example, might also help to allay concerns among less sophisticated investors. 
• Innovation: Digital tools, such as online platforms, robo-advisors, mobile applications and e-commerce platforms, will drive accessibility and put gold on a par with other investment assets 

Inflationary pressure and gold demand 

Inflation may also spur future interest in gold.  A persistent problem for India, inflation has regularly spiked above 10% over the past four decades, imposing considerable pressure on the economy. Between 2014 and 2020, however, average retail inflation remained below 5% (Chart 9), reflecting lower food price inflation and concerted action from the Reserve Bank of India (RBI).³³

In recent months, there have been signs of change. Food and fuel prices have started to rise and retail inflation has followed suit, reaching a six-month high of 6.3% in May 2021.³⁴ In the months ahead, soaring commodity prices and logistical costs are expected to impose further pressures and the RBI has already adjusted its inflation expectations higher, setting a forecast of 5.4% for the next three months from July to September, compared to 5.2% for April to June 2021.³⁵ Household inflation expectations have also risen, suggesting a growing concern among consumers about the months ahead. 

As we state above, rising inflation tends to drive gold demand. Gold is perceived as a strong hedge against inflation and decades of data supports this assumption. 

Looking back over the past 40 years, for example, gold has delivered an average annual return of 10% in rupees, clearly outperforming CPI inflation, which expanded by an average of 7.3% over the same period.⁴⁴  

Gold’s performance has also been particularly strong when inflation was high, increasing by 11% on average, when inflation rose above 7%.⁴⁵ As inflationary pressures tick up therefore, historical precedent would suggest that demand for gold will follow. 

Government policies and the impact on gold 

India is unusual. Even though the country is one of the leading sources of gold demand worldwide, there is almost no domestic production. As such, when demand rises, imports tend to rise in sync. This can, at times, have a significant effect on India’s trade balance and current account.

This was particularly in evidence after the Global Financial Crisis, when gold imports rose sharply, reaching a high of Rs2,922bn by FY 2012/13, almost 20% of total imports to India.⁴⁶ A combination of rising demand for gold, reduced demand for Indian exports and soaring oil prices had severe implications for India’s current account deficit (CAD). From less than Rs116bn in 2001, the deficit surged to Rs4,796bn in FY2012/13, equivalent to 4.8% of GDP.⁴⁷

Faced with this fiscal imbalance, the government-imposed restrictions on a raft of imported goods, including gold. Duties on gold imports increased fivefold in less than two years, from 2% in January 2012 to 10% in August 2013. The government also implemented the 80:20 rule, under which gold importers were required to export 20% of their gold as jewellery.⁴⁸ Recognised as unwieldy and market-distorting, the rule was scrapped in November 2014 but import duties remained at elevated levels. And in July 2019, they were raised still further to 12.5%, as part of a series of tax-raising initiatives designed to improve the government’s fiscal position.⁴⁹  

The basic custom duty (BCD) on gold was reduced to 7.5% at the Union Budget of 2021-22 but, in combination with other levies, total import duties on gold still stand at 10.75%, (compared to 12.875% before the budget).⁵⁰ 

The unofficial market 

Over the years, government policies on gold have had widespread consequences. Back in 2013 and 2014 for example, import duties and the 80:20 rule pushed up the gold price premium in the local market, created uncertainty and deterred some potential gold buyers. 

But there is a far more pernicious consequence of high import duties and other such restrictions: they tend to drive parts of the gold supply chain underground. Between Q3 2013 and Q4 2014, some 335t of gold was smuggled into the country, around a quarter of total demand. And, in the second half of 2019, while official imports fell and the CAD narrowed, unofficial imports surged by 42%.

In the face of huge, smuggled inflows of gold, the efficacy of successive import restrictions has been called into question. There is a further consequence too – the more pervasive India’s unofficial gold market becomes, the more difficult it is for the mainstream market to advance and develop. A reduction in tax rates could therefore confer benefits on two fronts. Lower duties would almost certainly boost overall demand for gold. And lower tax rates could create more opportunities for the compliant and organised sections of the gold market by squeezing out the unofficial or ‘grey’ market. 

This could have a meaningful impact on India’s role on the global gold stage. A direct consequence of high rates of duty, grey trading severely reduces gold’s role in mainstream financial services, it limits the appeal of India’s handcrafted jewellery overseas and it curtails India’s influence in the gold trading market. 

It should also be noted that gold imports have accounted for just 7% of total imports (Chart 10) over the past eight years. Over the same period, electronics imports accounted for 11% of total imports, while crude oil made up 24% of the total. The CAD has also fallen, averaging Rs2,112bn over the last seven years (Chart 11). 

Outlook

Demand for gold may be more subdued than expected this year, following India’s prolonged battle with COVID-19. However, imports remain strong and retail demand is expected to pick up, as restrictions are gradually lifted across the country. In 2022, economic growth and the impact of pent-up demand for gold are likely to presage a period of robust demand, although any future outbreaks of coronavirus could create further uncertainties.   

Looking longer term, the Indian gold market is influenced by both positive and negative factors. On the upside, the economy is expected to benefit from several robust structural factors. 

• First, rapid growth in the working age population over the next two decades will create a strong and sustained demographic dividend. 
• Second, continued urbanisation will drive and support economic expansion.
• Third, higher penetration of both the manufacturing and services sectors in rural areas will reduce their reliance on agriculture and deliver more stable incomes for millions of households.

As our econometric model illustrates, rising incomes are one of the biggest single drivers of long-term gold demand. This suggests that, as India’s economy grows, demand for gold should increase. However, the Indian gold market also faces several challenges.

• Households are saving proportionately less than they used to, which may reduce the amount of capital they allocate to gold.
• Financial inclusion is increasing, which provides investors with other sources for their savings beyond physical gold.
• Government policies can impact demand and inadvertently foster India’s unofficial market.
• Agricultural wages are still in decline, despite government actions in recent years. 

Taking all these factors into consideration, it would seem that the gold market is at a crossroads. Should government plan to increase farmers’ income by 2022 succeed, this would boost rural wages, lending further support to the market. Should the government choose to impose further tax increases, import restrictions or other adverse policies relating to gold, demand could be stifled or driven underground. 

Looking ahead, it would appear that India’s gold market is most likely to benefit from positive demographic and socio-economic changes if the industry takes steps to become more transparent, more standardised and more in line with global peers. The social and cultural transformations taking place in India should be underpinned by concerted efforts to provide easy access, and improve integrity and fungibility to reinforce trust in gold as an asset. 

Such moves would increase trust, boost confidence and allow the gold market to truly capitalise on India’s growing wealth. A more robust market would encourage Indian consumers and investors to see value in gold even as they become wealthier and more sophisticated. Overseas, a more reliable market would foster demand for Indian gold products the world over and allow India to take its rightful place on the global gold stage. 

Footnotes

¹IMF World Economic Outlook October 2021, GDP per capita in constant rupee terms

²We used a common approach to estimating long and short-term effects called Error Correction Model (ECM), which we applied to determine the drivers of gold consumer demand using data from 1990 to 2020. See Appendix 1 in the full report for more details.

³Prior to the 1990s, government regulation made gold imports illegal. This changed in 1992, resulting in a structural change in gold market dynamics. We concentrate on the period starting in the 1990s for three reasons: 1) to have a consistent model across the various demand categories; 2) to avoid difficulties modelling the structural shift; and 3) because econometric models using series for which the pre-1990s data is available and seemingly reliable (e.g. jewellery) delivered results consistent with those using post-1990 data.

⁴Consumer demand for gold is defined as gold jewellery plus bar and coin demand.

⁵Gold price level refers to the absolute gold price, rather than changes in that price.

⁶See Appendix 1 in the full report for more details.

⁷Gold Demand Trends, World Gold Council

⁸IMF World Economic Outlook October 2021

⁹This relationship holds when all the other variables are constant except inflation.

¹⁰In the second half of 2019, for example, the rupee gold price rose 15% while consumer demand fell by 24%.

¹¹Our models cover jewellery demand, bar and coin demand, as well as recycling; we don’t include an econometric model for gold ETFs, as they have been available to investors for less than 20 years, a good portion of which constitutes an accumulation phase, making it difficult to isolate the underlying macroeconomic drivers.

¹²United States Census Bureau.

¹³UN World Population Prospects 2019.

¹⁴Working age population growth, India Economic survey 2018-2019.

¹⁵RBI paper

¹⁶World Bank population estimates and projections.

¹⁷India Economic Survey 2017-18.

¹⁸Food and Agriculture Organization of the United Nations.

¹⁹NITI Aayog

²⁰ RBI’s monthly bulletin February 2021.

²¹ Statistical-Appendix-in-English.pdf (indiabudget.gov.in)

²²Consultancy.org

²³Consultancy.org

²⁴The per capita gold consumption is the range for minimum and maximum consumption per capita value during 2015-2020.

²⁵World Bank

²⁶World Bank

²⁷Microfinance companies are the financial institutions that offer small-scale financial services especially to the poor in rural, semi-urban and urban areas. Payments banks are a new model of banks conceptualised by the Reserve Bank of India. These banks can accept a restricted deposit but cannot issue loans or credit cards.

²⁸UPI goes live, banks introduce payment apps on Google Play Store

²⁹Internet World Stats.

³⁰Securities and Exchange Board of India

³¹Association of Mutual Funds in India.

³²Retail Insights, India.

³³In August 2016, the RBI announced an inflation target of 4% with 6% and 2% as the upper and lower tolerance levels, respectively, for the period up to 31 March.2021

³⁴Goldhub blog, World Gold Council

³⁵RBI’s monetary policy statement, June 4 2021

³⁶Bloomberg, Q2 refers to second quarter of the calendar year (January to December)

³⁷ Bloomberg

³⁸Metals Focus

³⁹Metals Focus

⁴⁰Metals Focus

⁴¹The relevance of gold as a strategic asset, India edition 2021

⁴²Bloomberg

⁴³Report of the Household Finance Committee, 2017

⁴⁴Based on average annual CPI changes for India as measured by the IMF from December 1980- December 2020.

⁴⁵The relevance of gold as a strategic asset, India edition 2021

⁴⁶Department of Commerce, Ministry of Commerce and Industry.

⁴⁷Reserve Bank of India.

⁴⁸The 80:20 rule came into effect on 22 July 2013 and was in force until 28 November 2014.

⁴⁹World Gold Council.

⁵⁰Union Budget Impact on Indian gold market.