March 21, 2012

Gold Crackdown at India

By Martin Denholm  of Wall Street Daily 

Barely a few seconds went by when I didn’t see someone, or something, clad in green.

Hardly surprising, really, given that I just spent the weekend of St. Patrick’s Day in one of my favorite cities – Boston.

But while the world’s Irish population was going green in celebration on March 17, it was a different story in India.

There, the predominant color was a somber shade of yellow.


Why?

The Economic Downside to India’s Love of Gold

India’s love affair with gold stretches back for many generations.

And it’s not just alluring as a store of investment value. For Indian culture, the yellow metal is a sign of high status, affluence and prestige.

Simply put, the more gold you can wear and own, the better.

It’s why the country is the world’s biggest gold buyer, importing over 900 tons of gold each year. Much of it goes to its thriving jewelry industry, with the World Gold Council stating that Indian jewelry demand for gold totaled 567.4 tons in 2011, versus 366 tons worth of investment demand.

Now you might think that the furious gold bull market over the past few years – and the massive runup in prices – would have deterred Indian gold buyers.

Not so.

Despite predictions of a flat year, if not a slowdown, India snapped up a record 969 tons of gold last year – a slight increase from 2010.

But there’s a downside. According to India’s Finance Minister, Pranab Mukherjee…

“One of the primary drivers of the current account deficit has been the growth of almost 50% in imports of gold and other precious metals in the first three quarters of this year.”

Indeed, Reuters quotes Macquarie research, which shows that of India’s 130-basis point jump in the current account deficit between 2008 and 2011, gold imports contributed to 40 basis points of it.

So in an effort to reduce the deficit and bring in more money from India’s clamor for gold, the government is taking a bigger piece of the pie…

As Irish Eyes Were Smiling, India Gold Buyers Were Sulking

Following a 90% hike to gold import duty in January, a further doubling of the levy to 4% kicked in on March 17.

That means for every 10 grams of gold imported, the cost will rise by 1,040 rupees ($20.25), according to Reuters. Not only that, the government will charge a 2% tax on jewelry that costs over 200,000 rupees ($3,896)

On hundreds of tons of gold, all this adds up. They say the duty hikes will cost them 15 million rupees through a combination of higher raw materials costs and buyers being squeezed. In protest, jewelers across India have extended a strike that started on Saturday until Wednesday. That’s a big deal, given that it’s wedding season in India when gold demand is at its highest.

So how will this news affect the gold market?

The Impact of India’s New Gold Duty on the Gold Market

With the new taxes on India’s gold imports, experts believe there’s both a short-term and long-term scenario.

In the short term, it’s likely that gold demand will fall, as Indian consumers adjust to the “new normal.” Additionally, the new, broader annual budget will result in some adjustment to household spending.

Over the longer-term, however, gold is deeply engrained within the Indian culture. Its allure and appeal isn’t something that will simply disappear, just because the government has imposed higher duties to cover a budget shortfall. India isn’t giving up gold any more than America is giving up the NFL! Both are influential, defining elements of their respective cultures.

In addition, the fact that gold prices have declined from $1,900 at the tail end of last summer to $1,651 today offsets some of the increased duty for Indian importers and consumers.

Analysts also believe some “importers” will try to bypass the levies by smuggling gold into the country instead.

Ultimately, the gold supply and demand issue in India essentially hinges on how long the government’s higher import duties last. If it’s a short-term hike in order to close the budget gap, the impact could be minimal. But if it’s a longer-term – or permanent – measure, I’d expect Indian gold demand to cool substantially from its recent record pace. And because it imports so much, it would likely drive down the broader price of gold.

Courtesy   Martin Denholm  at Wall Street Daily (EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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