India’s consumers might have been jealous of King Midas’s touch. The country’s historical affinity for gold has reached new extremes thanks to a weak economy, a falling rupee, and poor financial alternatives.
In the past year, India’s economy has been beleaguered by poor performance. Corruption, a lack of competitiveness, and a reform-resistant political system have neutered what was once considered Asia’s next Tiger economy.
Riding this wave of economic pessimism has been the depreciation of the rupee, which has reached near historic lows against the dollar. As a result, consumers have been flocking to gold as an alternative investment. Already the world’s largest gold importer, this increased demand has widened India’s already large current account deficit. To stem this flow, Indian policymakers have proposed tariffs on gold imports, hoping that such measures will stifle demand.
Such limitations are ill-advised. These proposed tariffs miss the underlying reasons why Indian citizens covet the metal. With a weak rupee and a financial system that lacks diversification and penetration, Indians are simply converting their money to gold because it’s a good investment. With gold prices soaring over the past 10 years, this is not surprising.
This demand for everything from bullion to jewelry is a symptom of India’s poor policy choices. The country’s prescription should be more economic freedom and greater openness to foreign finance, rather than the coercive practices such as tariffs and taxes.
To tackle the problem, Indian politicians need to address financial reform. First, state-owned banks should be privatized. Such banks make up nearly three-quarters of all loans in India, and their dominance limits the financial innovation that would provide Indian consumers productive alternatives to gold investments.
Second, India must let foreign banks in. Tough licensing requirements for foreign bank branches have prevented large and innovative institutions like HSBC and Citigroup from opening up commercial services. These restrictions limit the penetration that these banks can achieve, and prevent Indian consumers from investing in their diverse product lines.
According to the Heritage Foundation’s 2013 Index of Economic Freedom, India’s financial freedom is sub-par—ranking 106th in the world and well below the international average. If Indian policymakers really want to enrich their citizens, provide credit to small businesses, and achieve a sustainable solution to their country’s addiction to gold they must turn to economic freedom.