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Gold vs Inflation Indexed Bonds

Govt. is not happy with Indians buying huge amount of gold...year after year. Naturally so! There is hardly any gold mined in India. Therefore, gold has to be imported to meet this consumer demand. This means dollars outflow. Moreover, due to global financial crisis, the gold prices have gone up sharply over the last 5-6 years. This has meant additional outflow of dollars for every gm of gold imported.

This higher demand for dollars makes the dollar expensive i.e. the rupee depreciates. This means higher costs involved in importing essential items like oil, coal and edible oils. This increases inflation. Higher inflation pushes people towards gold, which is seen as a hedge against inflation.

So this has become a vicious circle. 

To break this vicious circle, the Govt. has increased import duty on gold. It is has put some restrictions on lending against gold. And now, to wean people away from gold, Govt. is ready to launch inflation-indexed bonds (IIBs).

As discussed in an earlier post, prima facie IIBs appear to be a good product. (We shall get a clearer picture once the details are announced).

But will IIBs be attractive enough to charm people away from gold? I doubt. There are many reasons for the same.

a) Gold can be bought even in the smallest of the town and village, whereas IIBs will be accessible only in cities and big towns
b) Gold needs no paperwork
c) IIBs cannot be bought with "unaccounted" money
d) For many small businesses/traders gold is a convenient collateral
e) Gold is extremely liquid. IIBs, on the other hand, have a 10-year tenor and even if listed, easy liquidity looks unlikely. 

All in all, a good product, but may not achieve its intended objective.

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