Gold in Equity Funds Risks Expanding India’s Import Burden

When the Securities and Exchange Board of India recently permitted equity mutual funds to invest a portion of their portfolios in gold and silver, the move might have been framed as progressive and investor-friendly. On the surface, it is hard to disagree. Gold and silver have delivered strong returns in recent years. The former serves as a hedge against inflation and geopolitical uncertainty and offers diversification benefits in volatile markets. Allowing small investors to access it through regulated collective investment vehicles rather than through impulsive physical purchases appears sensible.

Yet in India, gold is not merely another asset class. It is a macroeconomic variable. And that distinction makes the policy more consequential than it first appears.

Modern portfolio theory recognises gold as a low-correlation asset that can reduce overall portfolio volatility. Equity mutual funds, especially large and diversified schemes, can use modest gold allocations to cushion drawdowns during global shocks. Retail investors, instead of separately buying gold ETFs or jewellery, gain structured exposure under professional management. In theory, this improves financial sophistication and protects households from concentration risk.

However, macroeconomics rarely rewards tidy theoretical constructs.

India remains one of the world’s largest consumers and importers of gold. Unlike crude oil, which fuels production and transport, gold largely sits idle in vaults and lockers. It does not generate productive capital or expand industrial capacity. Domestic production is negligible, meaning incremental demand is overwhelmingly satisfied through imports.

This has direct implications for the current account deficit. Historically, surges in gold imports have widened the trade deficit, increasing reliance on capital inflows to finance external imbalances. The 2012–13 episode remains instructive when India’s Current Account Deficit breached comfortable levels, forcing policymakers to impose curbs on gold imports, raise duties, and introduce the 80:20 rule to stabilise the external account.

Gold, in India’s context, has repeatedly intersected with currency and balance-of-payments stress.

Thus, the key question is not whether gold is held in a locker or a custodian vault. It is whether total demand rises.

A related concern lies in ETFs and related domestic pricing dynamics. Gold ETFs are said to “financialise” demand and are superior to physical buying. ETFs are transparent, regulated, and reduce informal channels and smuggling. However, the underlying arithmetic does not change. Gold ETFs must back their units with physical bullion. Net inflows into ETFs ultimately translate into incremental gold imports unless matched by domestic recycling.

In theory, ETF prices should closely track international gold/silver prices adjusted for currency and other transaction costs, including import duties. In practice, India often witnesses persistent domestic premiums driven by seasonal demand, supply bottlenecks, and import constraints. These premiums are not always grounded in global fundamentals. And we have seen a sharp fall in gold and silver ETF prices.

If large equity mutual funds, managing trillions of rupees, begin allocating even a small percentage to gold, the aggregate demand impulse could be meaningful. Institutional participation may amplify ETF inflows, which in turn could push up physical demand and widen domestic price premiums.

External risks
Timing further complicates the picture. India’s external sector remains exposed to global volatility. Foreign portfolios continue to be fickle. The IT services sector, a major source of invisible earnings, faces structural uncertainties from automation and global tech spending moderation. In such an environment, encouraging structural increases in gold imports could introduce additional pressure points in the balance of payments.

This is not an argument for financial repression or banning gold exposure. Rather, it is about regulatory signalling and capital allocation priorities. When regulators expand channels for gold investment within mainstream equity funds, they confer institutional legitimacy. Even modest reallocations toward a non-productive imported asset warrant reflection.

To be fair, the impact may prove limited. SEBI’s caps on exposure are unlikely to transform portfolio structures overnight. 

But policy coherence demands anticipation of second-order effects. India’s gold policy history has oscillated between liberalisation and restriction, depending on external conditions. If gold imports rise meaningfully and external stress re-emerges, policymakers may once again confront the uncomfortable choice between imposing curbs, tolerating wider deficits, or absorbing currency pressure.

A more calibrated approach could align financial innovation with macro prudence. Gold allocation limits might be dynamically reviewed against external account indicators. Greater emphasis could be placed on gold monetisation schemes to recycle idle domestic stocks.

None of this negates gold’s role as a hedge. It merely recognises that in India’s macroeconomic architecture, gold is not neutral.

Yet financial regulation does not operate in a vacuum. In an import-dependent economy with periodic external vulnerabilities, even seemingly incremental changes can carry macro significance.

The debate, therefore, is not about whether gold deserves a place in portfolios. It is about whether expanding institutional avenues for gold demand aligns with India’s broader external stability and development priorities.

In finance, diversification is prudent, but in macroeconomics, prudence requires asking what exactly is being diversified and at whose cost. Macro prudential points aside, the segmentation of commodity and equity mutual funds exists for the reason that if consumers so desire, they can construct a portfolio with suitable weights based on their appetite. The issue of tying up commodities with equity for diversification's sake is not the answer to it.

Where does the quest for such diversification end ­– Bitcoin next?