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.