The Reserve Bank of India (RBI) and finance minister P. Chidambaram are focusing on gold as a cause of the country’s deteriorating macroeconomic numbers. The current account deficit has been widening, and gold is the second biggest contributor to the import bill after crude oil.

“There is a need to moderate the demand for gold imports considering its impact on the current account deficit,” says the draft report of a RBI working group on gold, released on January 2. In New Delhi, in a simultaneous development, Chidambaram told the media that the government would have to revisit the import duty on gold, to make the yellow metal more expensive. The duty is currently 4%. “Demand for gold must be moderated,” he said. “[We] cannot afford to spend so much on importing gold. Nobody says gold within the country should not be used for whatever purpose. There is enough gold within the country. But import of gold is a huge strain on the current account.”

In the first half of financial year 2012-2013, the current account deficit was US$8.7 billion, 4.6% of GDP against a comfort level of 2.5%-3%. Gold imports stood at US$20.25 billion. Chidambaram estimates that the full financial year will see gold imports cross US$40 billion.

Gold has always been the favored form of investment in India. Even the poorest families have some gold saved away for a rainy day. “India is the world’s largest gold consumer market,” says a World Gold Council (WGC) report titled “India: Heart of Gold.” “Unlike other gold markets, the love for gold has not only spread across many generations but also across all social strata.”

India and China are the two biggest markets for gold in the world, accounting for more than 25% of total demand. China was expected to overtake India, but that hasn’t happened. In the July-September quarter of 2012, global gold demand was 1,084.6 tons (valued at US$57.6 billion), down 11% from the corresponding period the previous year, according to WGC figures. Demand in India was up 9% to 223.1 tons. In China, however, demand fell 8% to 176.8 tons.

The RBI has suggested various ways to temper Indian demand and to use gold more productively. The draft paper says that fiscal measures may be revisited, which in lay language means that import duties should be raised. The problem, as the paper points out, is that “purchases from unauthorized sources of supply” — smugglers, in lay language — will increase. C. Rangarajan, chairman of the Prime Minister’s Economic Advisory Council, recently pointed out that banning gold imports will push up smuggling. He said that there were already signs of that happening. The government had hiked the duty on gold imports in January 2012 from a flat Rs. 300 (US$6) per 20 gm to 2% of value. This was further increased to 4% in the Union Budget.

According to Rangarajan, gold is primarily a hedge against inflation. When inflation comes down, so will demand for gold. The RBI paper goes a step further. It suggests the introduction of inflation-indexed bonds to wean away gold hoarders. It has also suggests several gold-backed financial products.

Gold has seen much activity in India in recent times. Earlier, it was mainly jewelry that was in vogue. Now, banks are doing good business selling gold coins and bars. Various specialized non-banking finance companies (NBFCs) have sprung up offering loans against gold and gold jewelry. These were looked upon with suspicion because of the many complaints against them. The draft paper gives them qualified approval. “Banks and NBFCs may continue to deliver gold jewelry loans, which monetize the idle gold in the country,” the paper says. “The gold loan market has grown well in recent years. It is time for consolidation of the operations of the gold loan NBFCs. [They] need to transform themselves into institutions free of complaints, [with] proper documentation and auction procedures, [and a] rationalized interest rate….”

The paper is, in fact, more concerned about the gold NBFCs than gold imports. Though it is dotted with caveats, the draft has been welcomed by the industry. “The committee’s report on the gold loan sector is very positive,” says George Alexander Muthoot, managing director of Muthoot Finance, one of the few listed companies in the sector. Muthoot shares shot up nearly 20% on the Bombay Stock Exchange on January 3.

“The release of the report will remove the negative perception created in the market about the gold loan business,” continues Muthoot. “Apart from suggesting some hygiene factors to be inculcated, the gold loan companies’ role in monetizing and creating liquidity for the gold available in the country has been appreciated in the report. This report has also concluded that gold loans have no impact on gold imports.”

In the first wave of liberalization, Manmohan Singh, then finance minister and now prime minister, had removed curbs and duties on gold imports. In the new burst of reforms, his successor Chidambaram is bringing them back.