ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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India's Elasticity of Demand for Gold

This article is intended as an introduction to I G Patel's writings on India's gold problem, following the publication for the first time in this issue of his pioneering International Monetary Fund research paper, 'India's Elasticity of Demand for Gold', dated August 21, 1950. The introductory essay evaluates the paper as well as Patel's anonymous article, 'On Turning Gold into Base Metals', in Economic Weekly, July 1958 which analyses different modes of mobilising India's hoarded gold through incentives, compulsion and sustained propaganda. As a civil servant, Patel was also involved in various issues of gold policy. The article also underscores the contemporary relevance of Patel's pioneering research on gold, taking account of subsequent literature, and outlines a research programme, in consonance with the state of the art, to address the still unresolved problems of the analysis of gold demand and the mobilisation of gold for productive use.

I ndia has been famously described as the perennial sink of the precious metals (Stanley Jevons) and the first Indian governor of the Reserve Bank of India (RBI) underscored this theme: “Gold and silver run like twin threads in India’s economic destiny and operations in those metals have occupied quite a substantial part of the time and attention of the executive of the Reserve Bank” [Deshmukh 1997: 26]. These observations sum up the analytic and policy aspects of India’s perennial gold problem, which consistently engaged Patel’s attention in later years as an economic advisor and ranking civil servant. What determines the virtually insatiable appetite of India for gold and how does one mobilise its gold for productive purposes? It was therefore uncannily appropriate that the young I G Patel, destined to be Deshmukh’s mantle-bearer, began his career in the IMF with a pioneering research paper on ‘India’s Elasticity of Demand for Gold’ (August 21, 1950). It estimated the responsiveness of India’s demand for gold to changes in its relative price (dependent variable) by attempting to correlate the net flow of gold from (or into) private hoards during the period 1925-42 and 1949-50 (April-May) with two independent variables: the relative price of gold and the consumption of refined sugar as a proxy for real national income. The results suggested that: the demand for gold was highly responsive to changes in its relative price. Patel argued that, historically, price has been a more important explanatory variable than income, allowing for the fact that the shortcomings of the data used tend to overestimate the price-effect and underestimate the income-effect and that the effect of a certain increase in income may not be symmetrical to the same decline in income. The assumption of linearity of the underlying relation also implies that over the period considered, no factors other than price and income supervened, assumptions which were recognised to be questionable, particularly the changes in the distribution of income induced by changes in the terms of trade between agriculture and non-agricultural occupations. But apart from this, the period 1925-26 to 1941-42 seems to have been reasonably free of random offsetting factors. Patel also recognised that in any analysis of demand for gold, which is both a consumer good and a vehicle of savings, the assumption of a linear functional relation

coupled with variations in real income around the subsistence level, complicates matters. Likewise, he rightly cautioned about the perils of extrapolating his results given, among others, the exceptionality of the period 1925-40 when India had no experience of serious inflation or political instability, which are among the most potent customary factors, propelling the demand for gold. He, however, sensed the emergent role of gold as a medium of tax-evasion in the post-war era.

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