www.bloomberg.com
By Bruce Einhorn and Anto Antony
Abin Baby, an unemployed teacher from the town of Thodupuzha in the
southern Indian state of Kerala, was in a bind. He needed money to cover
some emergency expenses, but since he was out of work, he couldn’t
easily get a loan from a bank. So in August he took a 14-gram gold
bangle and used it as collateral for a six-month loan of 27,500 rupees
($402) from Muthoot Finance, one of the leading providers of gold-based
loans in India.
Such loans are a primary way to borrow money in
rural India, where gold is an especially popular gift at festivals and
weddings and millions of poor people don’t use the banking system. The
interest rate on Baby’s loan was 18 percent. Not having many options, he
decided getting the loan was worth the expense. The transaction
happened “quickly and smoothly compared to the banks,” he says.
The gold-loan business has suddenly gotten bumpy. Prime Minister
Narendra Modi’s decision last month to invalidate all 500-rupee and
1,000-rupee notes has Indians scrambling to get their hands on valid
currency. Because almost three-fourths of payments for gold-loan
interest and principal are made in cash, as opposed to, say, bank
transfers, the shortage of legal tender is hurting lenders. Modi’s move,
known as demonetization, is designed to crack down on tax evasion by
forcing people to tender their cash to the bank, where it can be
recorded.
“Demonetization will be a blow” for the gold-loan business, says Payal
Pandya, an analyst with Centrum Wealth Management in Mumbai, who
estimates the companies may have to slash projections of loan growth for
the year by 5 percentage points to 7 percentage points. The stock price
of Manappuram Finance, a lender that has 66 tons of gold in collateral,
dropped 25 percent in the 15 trading days following Modi’s
announcement, while Muthoot’s fell 16 percent. Loan repayments declined
in urban and rural areas, says V.P. Nandakumar, Manappuram’s chief
executive officer. A shortage of cash is also putting the squeeze on
India’s $40 billion market for jewelry: Transactions will shrink as much
as 30 percent because of the shortage of notes, according to a Nov. 23
report by Ambit Capital analysts.
Modi’s timing is especially bad for PC Jeweller, a New Delhi-based
manufacturer and retailer. The company gets more than 90 percent of its
revenue from wedding-related sales, according to Chief Financial Officer
Sanjeev Bhatia, and the currency shortage is taking place in the midst
of wedding season. “Whatever sales we should have been doing at this
point of time—perhaps we are doing 40 percent of that,” Bhatia told
analysts on a conference call on Nov. 24.
Almost all of India’s gold is imported, and successive administrations
concerned about its impact on the country’s currency and trade balance
tried for years to weaken gold’s prominence in the economy. Starting in
the fiscal year ended March 2009, India’s consumer price index rose by
8.9 percent or more a year for five consecutive years; gold imports
increased in turn, from $17 billion in 2008 to $56 billion in 2012,
putting pressure on the current-account deficit. In response to that
soaring demand, the government of Modi’s predecessor, Manmohan Singh,
raised taxes on imported gold three times in 2013, to 10 percent. The
country remains the world’s second-largest gold consumer after China—it
now has more than 20,000 tons of the precious metal.
To reduce people’s need to buy gold as an inflation hedge, Modi’s
government in November 2015 introduced an eight-year bond offering a
redemption price linked to the price of gold. The bonds, says the
finance ministry, eliminate the risk and cost of storing the precious
metal. The government also exempted individual holders of these bonds
from taxes on their capital gains.
In March, after Modi’s finance
minister, Arun Jaitley, announced a 1 percent excise duty on gold
ornaments made and sold in India, angry jewelry shop owners responded by
shutting their doors in protest for most of March and part of April.
The biggest bullion refinery, MMTC-PAMP India, shut operations from May
to September because of weak demand. According to the World Gold
Council, Indian consumers’ demand for gold in the third quarter of 2016
fell 28 percent from the same period a year earlier, to 195 tons.
Centrum’s Pandya says the disruption may be short-lived. Muthoot and
Manappuram are already shifting many transactions online, eliminating
the need for cash payments. Within a year, 70 percent of Muthoot’s
transactions will be digital, says Managing Director George Alexander
Muthoot. Smaller rivals “will be hit more by the cash ban, as they don’t
have access to digital channels for disbursals and repayments like us,”
he says. “We are reorienting our strategy to push digital transactions
as much as we can.” Manappuram has introduced a service allowing
borrowers to get loans quickly over the internet, using gold they’ve
stored in its vaults. The company hopes to convert one-third of its
gold-loan customers to the online system within 18 months. Gold, says
CEO Nandakumar, “is seen as the poor man’s credit card.”
The bottom line:
India’s government wants the economy to be less reliant on cash and
especially gold, which many Indians use to store their wealth.
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