Q: What links Turkey, India and Vietnam?
A: Weak currencies, trade deficits — and a suspicion that gold is to blame.
Here’s the scenario: a falling currency, a widening trade deficit, and a population buying more and more gold. What’s the result? Well, it tends to be an unhappy government, followed by a policy response.
We’ve seen it Vietnam, where central bankers continue to make noises about “mobilizing” the country’s privately held gold, having last year handed an effective monopoly to a single refiner (later “administratively acquired” by the central bank).
We’re seeing it in India, where the government has quadrupled import duties since the start of the year.
And we may be about to see it in Turkey, where, the Wall Street Journal reports, the government is set to publish plans designed to encourage people to deposit their gold bullion with the country’s banking sector. One proposal reportedly being considered would involve interest-paying gold deposit accounts, with depositors being offered the ability to withdraw gold bars from ATM machines.
It remains to be seen whether this will get off the ground and whether it will be successful.
“The tradition of holding gold outside the system could be hard to shift,” reckons Murat Ucer, an economist at Istanbul-based research firm Global Source Partners.
If the scheme does go ahead, it will be the latest move by Turkey’s authorities to inject a bit of gold into the nation’s banking system. Last November, the country’s central bank announced that banks could hold up to 10% of their reserves in gold.
The backdrop to all this is a falling currency, allied to a balance-of-payments problem. The Turkish lira fell 23% against the dollar in 2011. Turkish gold demand in the fourth quarter of last year was up 128% year-on-year, according to the latest World Gold Council data.
Over the year as a whole, gold-jewelry demand fell slightly, but demand for gold bars and coins, which people tend to buy primarily for investment purposes, rose 99%, to 80.4 tonnes. (Turkey was the world’s largest producer of gold coins last year.)
Almost all of that demand was matched by imports, with Turkey importing 79.7 tonnes of gold in 2011, according to data from the Istanbul Gold Exchange. This is not great news in a country whose current account deficit is around 10% of GDP.
Here we have a clear case of cumulative causation: The Turkish Lira depreciates, people hedge by buying gold, the gold has to be imported, thus putting further pressure on exchange rate and widening the trade deficit.
It’s not clear how gold deposit accounts are supposed to break this cycle. Perhaps the government hopes that if banks have gold on their balance sheets, this will boost confidence in the financial system, diminish the propensity to buy gold and in effect support the lira.
Or perhaps the authorities think that by gathering a “liquidity pool” of gold, banks will be able to meet spikes in domestic demand without the country needing to rely as heavily on imports. In effect, banks would lend out depositors’ gold, much as they already do their cash, holding a proportion in reserve from which to satisfy any withdrawals.
If this is what Turkey is considering, it would involve the obvious risk that banks could be subject to a run. Gold depositors, one suspects, would be most likely to try to take their gold back when (a) financial or economic stress has created a need for them to realize its value. and (b) they fear the bank with which they’ve deposited the gold may be about to go under.
Both such scenarios have in recent times tended to occur together. Furthermore, they are often (though not always) associated with a rising gold price as investors run to perceived safe havens.
A run on gold deposits is arguably more likely than a run on cash. Government deposit guarantees are one way of maintaining confidence and avoiding a run, but these are more credible for cash deposits than they would be for bullion. Unlike domestic currency cash deposits, gold deposits cannot be guaranteed by a government unless that government has large gold reserves it is prepared to see diminished, or it is willing and able to buy gold then and there on the international market.
Neither move could be expected to promote confidence in the currency, bringing us right back to the situation in which Turkey now finds itself — a weak lira, a weak current-account position and a population fleeing to gold. The other option, of course, is that a government could shift the goalposts, denying depositors access to their gold.
The history of gold-deposit schemes does not bode well for Turkey’s planners. India, another country that last year experienced a depreciating currency and a rising domestic gold price, launched a gold-deposit bond scheme in 1999 through its largest commercial bank, the State Bank of India. It was not a roaring success, but that didn’t stop the SBI from relaunching the scheme in 2009.
Neither version of the gold-bond scheme managed to prevent India’s gold imports from rising dramatically in recent years, with all the attendant effects on the exchange rate and balance of payments.
So Indian policymakers have changed tactics. This week, they moved to limit gold’s value as collateral, with the central bank imposing a cap on the loan-to-value ratio gold-financing companies can offer. Reducing the financial utility of owning gold may not have been the primary motivation for this move, but it is a side effect that is unlikely to worry authorities.
What most definitely is designed to curb gold demand is last week’s announcement that India is doubling gold import duties for the second time this year, which sparked a strike by Indian gold dealers. Finance Minister Pranab Mukherjee specifically cited gold imports as “one of the primary drivers of the current-account deficit” and a major cause of rupee weakness.
As MineWeb reports, one side effect of last week’s move is the possibility that imports of jewelry routed through Thailand could now end up cheaper than those produced in India, since a free-trade agreement between the two countries means that imports from Thailand are currently subject to a much lower duty.
Domestic gold-jewelry makers are understandably upset. This may well be an unintended side effect rather than a deliberate policy and one that the government may well iron out. The structure of gold import duties now seems designed to give an edge to the domestic refining industry, with unrefined gold being subject to a lower duty than refined. It would seem perverse, therefore, to allow a situation to persist whereiny domestic jewelers lose out while gold imports are barely stemmed.
Another country with direct experience in gold deposit accounts is Vietnam, which in recent years has also suffered from currency weakness and a current-account deficit.
Vietnam’s central bank is something of a pioneer when it comes to domestic gold market regulation. Last May saw the State Bank of Vietnam ban gold-lending activities, at that time the latest in a series of interventions in the gold market.
What happened next is interesting. Authorities issued a decree to the effect that refiners of gold bullion should have a minimum of VND500 billion registered capital, as well as a domestic market share of at least 25%.
They must have known that the market was dominated by a single refiner, Saigon Jewelry Co., whose market share was around 90%.
Having handed Saigon Jewelry a monopoly, the SBV announced in November that it had “administratively acquired” the refiner. Then a rather odd thing happened. The SBV’s former governor, Cao Sy Kiem, said that the central bank should issue gold certificates as a way of mobilizing privately hoarded bullion.
In January of this year, current SBV governor Nguyen Van Binh also spoke of “mobilizing” gold for the “socioeconomic development” of the country, suggesting a role for credit institutions suspiciously similar to the one they were performing before the SBV shut them down.
In Vietnam, it would seem, gold should be mobilized only after the government is in a position to call the shots.
There would seem to be a deeper trend here. Vietnam, Turkey and India are all emerging economies whose governments, faced with currency and balance-of-payments problems, have identified gold as an area worthy of attention. So far, Turkey is considering the carrot of paying interest on deposits and giving incentives to banks to hold gold. But the experiences of India and Vietnam suggest that at some point it may choose to pick up a stick.
Another country whose authorities may be paying closer attention to its citizens’ appetite for gold is China. As reported last month, some dealers are finding that it now takes longer to import gold since importers need to get permission from the State Administration of Foreign Exchange as well as the People’s Bank of China.
China saw its gold imports from Hong Kong triple last year. Are authorities beginning to worry about the impact of gold on the country’s trade position?
If emerging-market policymakers continue to flex their regulatory muscles, this could have significant implications for global gold demand. Consumers in India and China accounted for one of every two ounces of gold bought last year. The growth in demand from these two countries — from China in particular, which only deregulated its gold market at the start of the last decade — has been a driving force behind gold’s bull market.
There’s probably a limit to how far policymakers are willing to risk alienating populations who have demonstrated a desire to buy gold. In India, Mukherjee has said he does not intend to raise duties any further; time will tell if the government sticks to that. In Vietnam, for all of its many decrees, leaders have been keen to pay lip service to private gold ownership and have said they will continue to permit it.
So where’s the limit? Stay tuned.