Global financial crisis keeps looming ominously manifesting itself most vividly in India. The Indian government has recently announced that large denomination banknotes are no longer legal which caused chaos and frustration amongst Indians. Now, it turned to gold reserves.
In its effort to combat the financial crisis, Indian government denominated 500 and 1,000 rupee notes which constitute 85% of the overall money stock. It’s quite easy to imagine the sweeping consequences it caused including huge queues at the country’s banks.
Now, the most troubling fact is that gold isn’t the only asset the government targets. Media reports on cases of the police confiscating jewelry with no answers given to the owners.
Potential Effect of Indian “Gold Policy”
The government denomination policy is likely to cause a series of disrupting effects. This is especially true for rural India where the economy is fuelled by cash. Moreover, these effects will most likely last for at least several quarters, albeit experts find it hard to predict more or less accurate duration and scale. The prevailing opinion, however, is that of the former Prime Minister Manmohan Singh. According to his forecast, the new policy would decrease the GDP growth rate by 2%.
The initial intention behind denomination was to fight the shadow economy as richer Indians hold large amounts in cash and avoid paying taxes. Narendra Modi, India’s Prime Minister, is keen to view these measures as the means of developing a cashless, non-corrupt economy. However, the government is now facing tough questions, one of which is whether unclear denomination regulation facilitated money-laundering.
At the same time, the idea of the government set to eliminate the black money from the economy is supposed to appeal to the society so Prime Minister now has to conduct policies in line with this goal. This explains why non-cash assets like gold are now next on the list for fiscal services.
Public Reaction to New Regulations
Following these announcements, public anxiety skyrocketed. This forced the government to intervene with an attempt to quiet things down which didn’t appear to work out. In particular, the government declared it follows clear rules when it comes to confiscating gold. No confiscations will occur if the following limits are met: 100 grams of gold per male, 250 per unmarried female and 500 grams per married female. If the person holds inherited jewelry, it won’t be confiscated either. The tax officers were also instructed to not take away any more assets above what law abides.
What Does It All Mean in the Long Run?
In reality, however, the situation is quite different. First of all, it means that tax officials now hold an unprecedented power. They can single-handedly determine whether or not to take away gold from the owners. This is not to mention the fact that India holds huge reserves of gold (by some estimates, up to 20,000 metric tons). Instead of reforming the tax service itself, the government delegated more authority and influence to it than it has ever had. The rich can pay to avoid law consequences but the middle class and the poor and will have to go through it all.
There are already rumors (as well as some evidence of it) that those close to political circles were informed about the gold confiscations and got themselves ready for it. The rest of the population is left to deal with the situation as it unwinds.
In the long-run, these government policies will most likely increase the demand for gold.
Without a doubt, keeping one’s assets in gold is the best way to protect financial interests at a time when the global crisis picks up. Government policies like those in India, however, threaten to contradict this concept altogether.