Relationship of Gold and Inflation in India

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Hidayatullah National law university-Raipur|
Relationship of Gold and Inflation in the Indian context|
Project for Semester I|
|
Akanksha Dikshit|
8/21/2012|

The Project analyses the relationship of Gold prices and inflation in India. Gold holds a special place in the Indian psyche and cultural ethos. It influences the Indian economy like no other material. The study is based upon the study of existing research material.|

Acknowledgements
I thankfully acknowledge the help and contribution of my teacher Mrs……… and my seniors in pursuing this study which also happens to be my first serious endeavor in such a project work. I have tried to trace the affinity of gold for Indians and its very important role in the Indian economy. The study is based upon the existing resources on the subject and therefore understandably not conclusive.

The Distinctive Properties of Gold

Gold has been used as a store of value and form of currency since ancient times. Since the seventeenth century it has been formally traded over the counter in London and by the nineteenth century it underpinned the largest fixed exchange rate system the world has ever known (the Gold Standard). In the twentieth century it was again used as the backbone to a formal exchange rate mechanism (Bretton Woods) but the collapse of the system in the early 1970s left the price to float freely for the first time in over 250 years.

Gold’s historical popularity as a currency and a store of value has sprung in part from a number of peculiar properties not fully shared with competing assets. In contrast to other commodities, gold does not perish or degrade over time, giving it unique properties as a very long-term store of value. Gold mined today is interchangeable with gold mined many hundreds of years ago.

The supply of gold has also been relatively fixed for the last century, with annual mine production a small share of the total stock of gold outstanding and with a limited ability for annual production to rise in response to changes in the gold price. This marks it out from other commodities where substantial supply responses to price changes are possible, at least over the medium term.

Another important attribute of gold is it’s relatively less prominent use for industrial purposes, compared to other commodities including precious metals such as silver and platinum. Only around 10% of gold demand in 2010 came from such industrial uses2 with the balance coming from jewellery and investment demand. As a result, gold prices lack the strong link to the economic cycle that other commodities have and gold has thus often exhibited low or even negative correlations with these and other financial assets.

Gold is also unusual among financial assets in not delivering a yield, e.g. a dividend or coupon as paid by equities and bonds and this can be seen a disincentive to hold gold; however, gold has a significant advantage compared to some other financial assets which is its lack of default risk.

These factors give gold an unusual set of behavioral characteristics compared to other financial assets, which will be examined in more detail below.

Gold-Importance for Indians
Indians see gold as a precious commodity. Even in religious texts of Hindus, gold finds a mention as a commodity of immense values. They treat it as a metal to be possessed only by kings and gods. Like in other countries, in India gold is demanded for three uses, namely, jewellery, retail investment and industrial use. The demand for gold in India is the highest as compared to other developed and developing nations. The primary driver of gold demand is demand for gold jewellery. Gold traditionally has been demanded for making gold ornaments. The sale during the ‘Diwali’ festival and marriage season is high. Most of the sales are bunched during this time as Diwali coincides with harvesting and sale of crops. Gifting of gold ornaments to the bride is an age-old practice...
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