India's Golden Conundrum

Indian’s love for gold is spiritual where it is revered as God’s currency. It is only astronomically higher prices which can resist them to buy it. Falling prices are just what India wanted at a time when festival and wedding season is ensuing.

The king of metal Gold is again going south. It touched a 14-month low on September 20, 2014. Such a scenario induces people away from gold to flock into financial instruments. The metal will no longer lure Indians is what analysts believe but India’s thirst for gold will take eternity to be quenched.

Falling gold prices might lead people in other countries to ditch the yellow metal but Indian’s love for gold is spiritual where it is revered as God’s currency and people feel proud of owning it. It is only astronomically higher prices which can resist them to buy it. Gold demand slumped magically when import duty was hiked to 10% in order to control current account deficit. Now that prices are falling, it will be seen as an opportunity to purchase it on low in the hope of price-rise. Long-term return outlook of a common investor in India is always bullish on gold.

Current account deficit (CAD) narrowed sharply to $7.8 billion (1.7 per cent of gross domestic product) in the Apr-Jun quarter of FY 2014-15 from $21.8 billion (4.8 per cent of GDP) in the year ago period. The fall was strongly led by slowdown in gold imports which halved to $7 billion in the April-June quarter from $16.5 billion in the same quarter a year ago. However, the gold imports in the preceding quarter i.e. the Jan-Mar quarter of FY 2013-14 amounted to US$ 5.3 billion. 

To compare the two data, gold imports actually risen on quarterly basis. The reason is because RBI had eased some gold-import restrictions in the month of May which instantly drove the people to invest in gold. This uptick in demand is reflected in the gold import data of Apr-Jun 2014.

It is true that the gold investment at this juncture does not seem viable. Gold futures are trading lower. Improving global economy does not bode well for the metal, to boot. Stronger dollar is also contributing to Gold’s southward journey as gold is used as a hedge against movement in the US dollar, which means its prices will move inversely to change in value of dollar. Indian gold prices move in tandem with global prices depending on rupee’s value against dollar. Since India imports the yellow metal, a weaker rupee cushions a fall in gold price while a stronger local unit makes the metal cheaper. Given improving economic conditions, rupee may not depreciate much against dollar.

That said, why to invest in a declining metal when stock markets are doing well and lower inflation is making returns on savings schemes positive? The answer lies in a trend seen last year. Gold prices had fallen dramatically in Apr-Jun quarter of 2013. Questions were raised if it safe to invest in this yellow metal but coming true to the conscience of Indians, gold hit a record high of Rs.35,074 per 10 grams in August 2013. Hence, it is no hyperbole that Gold is the safest haven amongst all.

With the ensuing festival and wedding season, India’s gold buying binge is likely to be bumper. Low prices at this time are just what India wanted. Irrationally higher import duty had enforced them to stay away from the metal for long but now is the opportunity to buy it on dips. Thus, India’s golden problem is not yet resolved and it is too early to claim that the country’s CAD is normalized. India’s lure for gold can be suppressed but cannot be died in any case. 

Glittery Gold Jittery Government

Instead of cynically hiking import duty, Govt. would do well if it paves way for either virtual trading of gold or it should launch gold-indexed bonds instead of inflation indexed bonds.

Unmindful of its earlier failed efforts of controlling gold-import and discouraging its demand, Govt. once again resorted to the same trick by ratcheting up gold import duty to 8% from 6% (fourth hike within two years) disregarding the speculative undertone it might generate. Reserve Bank of India (RBI), in the vein of Govt., levied more stringent restrictions on banks to import gold and provide loans to public. Given the ballooning Current Account Deficit and badly depreciating rupee against dollar, curbing gold purchase seems the only viable step to Govt. to tame the imbalance of payment but it is highly unlikely if it would discourage the people to invest in gold as its being the safe and lucrative haven is a widely popular notion in the country challenging which is a tough nut to crack.

The unprecedented fall in gold prices in the month of April somewhat provided sense of relief to Government but unfortunately the impact of price-fall substantially got counterbalanced by surge in demand due to wedding and festival season in the country with gold imports touching 162 tonnes in May. Rising gold imports also pushed the trade deficit to $17.7 billion in April. Further trouble befell with the consistent depreciation of rupee which has now surpassed 57 against dollar bricking the prospect of even more widening CAD leading to even higher inflation which is already at an intolerant level.

It is in this backdrop that the Govt. has hiked gold import duty and RBI asked banks and nominated agencies to not import gold on a consignment basis for domestic use. Also, RBI disallowed import of gold on credit and advised banks to dissuade people from parking their savings in this glittery metal. Co-operative banks have been told to only lend against gold ornaments, gold jewellery and gold coins weighing up to 50 grams, amount of which must be within the Board approved limit. Though these measures might serve the purpose of Govt. in the shorter term but considering the fact that steps of similar kind have already been exercised earlier for no avail, it would not provide a medium term solution let alone long-term. The vicious cycle of yawning CAD, rising inflation, falling rupee and sputtering growth is the result of structural deficiencies but Govt. is hell-bent to put onus on Indian’s lure of Gold and fuel subsidies.

Considering the dearth of inflation-hedged investment options, Govt. has though launched the first tranche of Inflation Indexed Bonds but the fact that its coupon rate and principal amount are indexed against Wholesale Price Inflation (WPI) not Consumer Price Inflation (CPI), returns on these bonds would not be much profitable as its latter not former which directly affects the consumers. On the other hand Gold, despite its price-fall provides favourable return against rising inflation. Also, the ease of purchase, as against IIBs for which one has to go through the tedious system of opening bank accounts, filling up litany of forms, understanding complex formula etc, makes it handy and an obvious choice for investors over any other financial instruments.

Gold-frenzy is a global phenomenon. Only difference is that Government worldwide has channelled this frenzy into paper-based trading of Gold. Given this, instead of cynically hiking import duty, Govt. would do well if it paves way for either virtual trading of gold or it should launch gold-indexed bonds instead of IIBs. It is well past time to understand that it doesn’t matter how many hurdles or challenges being put up in the gold-game, Indians will bravely and enthusiastically sustain but would not give up till the end.