For years, the government of India, the world's second-most populous country, has made reducing gold demand one of its primary focuses. It seems that after years of failure, the government finally hit upon a fool-proof way to cut down on gold purchases: just take away the people's cash!
As intuitive as this concept may at first seem, it has proven to be a revelation for policymakers in India. The "cash ban" was only arrived at (and subsequently became successful) after countless other policies had been attempted (and subsequently failed).
Implemented independently, these various laws discouraging gold ownership had only a minor effect. They included imposing a 10% duty on imported gold; forcing gold importers to re-export 20% of their metal; forcing gold buyers to present a tax ID at purchase; and promoting bank accounts that allow depositors to earn interest on their gold. In each case, the results were negligible.
Yet India was still swamped with gold smuggling and unreported gold transactions. Rather than comply with the onerous laws, Indian citizens were finding ways to circumvent them. One commonality in the technically illegal side of the country's gold market was that this activity took place within the "informal economy"—i.e. cash-only.
In fact, a huge portion of business in India occurs in this over-the-counter manner. Banking services and electronic transactions are simply not a feature in a majority of Indian families' financial lives, especially rural farmers.
So late last year, Prime Minister Narendra Modi shocked everyone by suddenly removing all of the country's 500- and 1,000-rupee notes from circulation. As the two highest-denomination banknotes available, this represented over 80% of the cash circulating in India. Overnight, conducting business in cash became virtually impossible. For weeks, until the new replacement banknotes were distributed, commerce ground to a standstill.
No Cash? No Gold
Where the all-out assault on gold ownership had repeatedly come up short, Modi's cash plan was apparently the perfect solution. While much of the news coverage of the policy focused on its connection to the "war on cash" and how it is a step toward the full digitization of money, the cash ban's impact on gold demand shouldn't be understated. Remember that tradition, convenience, and an interest in avoiding burdensome taxes means most gold transactions in India are done in cash. The calculus became glaringly simple: take away the cash, and nobody can buy gold.
The Modi government cited a desire to curb black-market transactions and money laundering to defend its cash policy. It's not a stretch to imagine that Modi had gold in mind when referring to transactions on the black market. Meanwhile, the Indian government enjoys a one-time surge of billions of dollars in revenue thanks to more cash being placed in the banking system—and therefore being taxable. (Citizens had to deposit their old, demonetized notes into a bank account to avoid losing all of their value.) Steve Forbes has called Modi's cash overhaul "sickening and immoral."
When combined with the marginal effects of the other anti-gold laws and higher gold prices throughout 2016, the cash ban made it much harder for Indians to buy gold. As a result, the government succeeded in nearly halving the country's annual gold imports last year. The impact is still rippling through the Indian markets: In December, India's top gold import bank froze the accounts of a number of bullion and jewelry dealers in an apparent search for evidence of money laundering.
For all intents and purposes, the cash ban in India was by far the most effective form of curbing gold demand. As commerce in the country normalizes, however, one would expect this suppressed gold demand to return once again. For more great information about how innovation and evolution continue in the Indian gold market, take a look at this research by the World Gold Council.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.