Published: 27 Sep 2017

How gold saved India's economy?

Importance of Gold in Indian economy

The famous saying that life is full of highs and lows is true as ever. Life is unpredictable, and you can never know when or what the next curveball will be. This unpredictability does not just exist on an individual level but can also affect societies, cultures, and nations at large.

It seems that every so often, India finds itself in a bit of a tight spot. Whether it was demolishing the British Raj, the struggle of carving an independent India, the atrocities of the partition, or the Indo Pak and Indo China wars, there have been many obstacles the country has seen in the past century. Even years after it attained independence, the Indian economy has faced several setbacks over the years. The 1991 Indian economic crisis was one such instance that stands out as perhaps the worst financial crisis the country has ever seen.

The 1991 Indian economic crisis is a pivotal historical event that later made way for liberalisation, privatisation, and globalisation (LPG) under India's New Economic Policy. This one event and the reforms and measures that followed drove India GDP growth rate (gross domestic product) and left a long-lasting impact that can be witnessed in India's economy today as well. However, not many people realised the crucial role that gold metal played back then.

Quite frankly, gold saved the Indian economy.

Keep reading to know-how and why the metal remains an excellent investment option.

Indian economy in the 1980s

In the 1980s, the Indian economy witnessed massive changes. Over the 1980s, investor confidence slumped, and inflation rose to double digits. This, along with the current account deficit and currency devaluation, led to a sharp exchange rate depreciation, as documented by Dr Arunabha Ghosh in his research study Pathways Through Financial Crisis: India. The Indian GDP growth rate was at a fiscal deficit of 8%. In addition to this, the current account deficit was recorded at 2.5% of the GDP.

India started to have problems with the balance of payments by the mid-'80s, and the value of the Indian rupee had fallen drastically by the end of the decade. The Reserve Bank of India attempted to defend the currency by expanding international reserves and slowing the decline in value. However, all of these efforts were in vain.

The Gulf War of 1990-91 also contributed to the brimming chaos. There was a steep rise in the prices of oil. Combined with a drastic drop in foreign remittances from Indians overseas, India's foreign reserves were almost depleted by mid-1991. They fell from $1.2 billion in January 1991 to half by June of the same year. This meant that India could scarcely finance three weeks' worth of imports. The government was close to default, and the central bank had refused new credit. The government of India had to permit a sharp devaluation against major currencies – leading to a severe economic crisis.

Impact of gold on the Indian economy

Gold metal has always enjoyed a prominent position in India. Its use in jewellery is widespread and well-known in cultures across the length and breadth of the country. As relevant a role as gold plays in the country's culture, it also played an equally important role in its economic history.

India's immediate response to the 1991 economic crisis was securing an emergency loan worth $2.2 billion from the International Monetary Fund (IMF). India did this by pledging 67 tonnes of its gold reserves as collateral. The Reserve Bank of India had to airlift 47 tonnes of gold to the Bank of England and 20 tonnes of gold to the Union Bank of Switzerland to raise $600 million. This amounts to approximately Rs. 2,843.5 crore as per today's values.

Given India's long-standing and intimate relationship with gold, there was apparent public outcry following the announcement that the government had pledged gold reserves against the loan. The Chandra Shekhar government quickly collapsed following the airlift. Still, the decision to use gold as collateral did help to improve the balance of payments crisis and kick-start a new era of economic reforms.

There were also a few restrictions put on the import of gold. It was observed that the import of gold was destructive to the already scarce foreign exchange resources. As a result, gold imports were only allowed to those with a valid license. The government also levied duty on Indian's travelling from abroad who bought gold overseas. In addition to this, there were restrictions on the value and quantity of gold permitted per passenger. Later, when the budget of 1992-93 was announced, there was a partial liberalisation on gold imports. Passengers were now allowed to pay duty on importing gold in foreign exchange. The duty fee was also lowered from Rs. 450 for every 10 grams to Rs. 220 for every 10 grams of the gold metal. Passengers could also purchase gold from the State Bank of India's bonded warehouse.

Fast forward 18 years. The Government of India has come full circle and bought back 200 tonnes of gold from the IMF. This amount equals three times what was pawned during the 1991 crisis. This decision not only acted as a hedge against the falling U.S. dollar but, more importantly, signalled to the world that India had recovered and reminded economies that the nation was back on the map.

Moreover, gold's power has not diminished years later. Even today, gold is considered a popular investment that is preferred by beginners and experienced investors alike. It is an excellent hedge against inflation, depreciating currency values, and risk. It also provides diversification to financial portfolios. Additionally, gold has helped many women attain financial freedom for decades.

Gold has carried Indians through many centuries and has also helped India save its economy. Its role in the 1991 economic crisis cannot be appreciated enough. Hence, it is safe to conclude that gold is a viable financial instrument that can protect individual financial portfolios from market crashes and economic turbulences and save an entire nation on the brink of a major sovereign economic failure.