Fed impact on gold demand is the key

How are the government and the Reserve Bank of India (RBI) trying to check gold imports?

The government hiked import duty on gold to 8% on June 5 from 6% previously. The finance ministry?s action to raise duty tails a spate of curbs announced by RBI on import of gold by banks as well as other entities. Recently, RBI has extended the restriction on advance against gold on cooperative banks, a move aimed at curbing demand for gold; it has put restrictions on gold importers using letter of credit from banks for importing. All letters of credit to be opened by nominated banks and agencies for import of gold under all categories will be based on 100% cash margin. Accordingly, any import of gold on consignment basis by both nominated agencies and banks shall now be permitted only to meet the needs of exporters of gold jewellery. These restrictions are in addition to the proposal made in its annual monetary policy statement on May 4 this year, which said that while granting advance against the security of specially minted gold coins sold by banks, state/central cooperative banks ?should ensure that the weight of the coin(s) does not exceed 50 grams per customer?, while RBI has already put restriction on advances by banks and non-banking finance companies (NBFCs) against gold coins. This decision was taken by the government as a step to discourage gold buying.

Why is the government worried so much about gold imports?

All of this continues to demonstrate that the Indian government is determined to reduce gold imports into India. Clearly, they?d like to stimulate the local market and get people mobilising reserves within India as opposed to importing them. The government also worries that large amounts of savings locked up in gold curtail liquidity and it, therefore, reduces investment in infrastructure and other sectors of the economy which promote growth.

India is the world?s largest importer of gold and the precious metal is the biggest contributor to the import bill after crude oil. India?s swelling current account deficit (CAD), driven by robust gold imports, forced the government to raise the import duty on gold in January 2013 .This is the second hike in a row within a span of just six months as gold imports soared to a worrisome figure of 162 tonnes in May. CAD, which is the net outflow of foreign exchange, is deteriorating and tested a historic high of 6.7% of GDP in the quarter ending December 2012. Export figures in the month of April stood at $24 billion while imports recorded a high figure of $42 billion. Gold imports were to the tune of 864 tonnes in the calendar year 2012 and the figure stands at 256 tonnes for the first quarter of 2013 according to the World Gold Council (WGC) data. Moreover, WGC estimates gold imports to be around 350-400 tonnes in the second quarter of 2013, which is almost half of the last year?s total imports.

The ballooning CAD has also been the major culprit behind recent depreciation witnessed in the rupee, wherein it is trading in the vicinity of its all-time lows of 57.3250 and has been the worst performing currency in Asia in the last one month. Rupee weakness further adds to our woes as it reduces the purchasing power and makes imports costlier, especially imported crude oil, and further raises our heady inflation levels.

Will the current duty hike work this time as the earlier increases failed to reduce import

substantially?

The news of duty hike led to a sudden spurt in gold prices at domestic bourses as there was a proportionate rise in prices, factoring in the duty hike. The move is likely to put some pressure on the supply-side equation as there can be a shortage of gold in the marketplace, also as the gold duty cut will ease some demand for the metal in the immediate short term, which brings the demand-supply equation again at parity. The sheer appeal of gold and demand buoyed by heady inflation is likely to have a moderate impact of any rise in duties, though it may curb physical demand for the yellow metal to an extent.

As it is a step towards restricting the supply of gold, this move may lead to an increase in the illegal movement in India in terms of importing gold and, most importantly, the move will nearly cripple retail jewellery trade and raise the unemployment situation in the country as more than 1.5 million skilled labourers are involved in this sector.

So, what is the benefit to the government then?

The recent duty hike and government?s statement to consumers to cut purchases might not help to a very large extent, primarily due to the predilection for gold in India, the world?s biggest importer. However, the move of increasing the import duty could benefit the government as its revenues would surge even if imports don?t fall, as 2% duty hike on gold would imply a sizeable addition to the government exchequer. The government has been trying to make financial investments attractive to wean away people from buying gold as it is not considered to be a productive investment. With this target in mind, it recently launched and is promoting investment avenues like inflation-index bonds which will help it to meet the growth target as well.

Also, one must keep in mind that the government has still got a few more alternatives to bring down gold imports, which includes increasing the import duty further or banning the gold coin sale by banks and even reassessing the current policies of import, if required, that can affect the demand-supply equilibrium in the precious metal for some time and bring some relief to deadly CAD, while adding to woes of the domestic gold industry.

How are gold prices expected to move from here?

While the prices soared immediately after the duty hike but the euphoria was neither backed by the buying at higher levels nor supported by the prices in the international markets which have been slightly soft. Prices have also been heading higher in the Indian market due to rupee depreciation but, going forward, gold prices are likely to be in sync with the international market trend once the effect of government action is absorbed. Alongside, the recent non-farm payroll data released in the US showed a pick-up in the employment, which warrants that the Federal Reserve could begin to scale back its monetary stimulus later this year, which has been a major supporting move for the bull run in the gold prices over last few years. This roll-back will bring the price of gold lower in the international markets, which will once again inflate demand in the domestic markets and nullify the impact of these measures by the government as witnessed in the month of April, following a massive drop in prices. The current price set up does indicate that in the short term prices will find it difficult to sustain at higher levels of R28,100 per 10 gm at the MCX, and at COMEX too $1,430 per ounce remains a key resistance while the persisting medium-term downtrend can drag prices lower towards $1,250-60 per ounce at COMEX and around R24,200 per 10 gm at MCX.

Having said that, given the inelastic nature of demand for gold in the country and a history of more than 5,000 years, the yellow metal will continue to see physical buying coming in at lower levels.

The author is AVP & in-charge, metals, energy & currency research, Religare Securities Ltd