The last time an Indian government raised import taxes, in August 2013, demand for gold jewellery fell sharply and took about a year to recover to previous levels.
Gold’s recent rally to a six-year high is suddenly looking a little more fragile after India, the world’s number two buyer, unexpectedly hiked import duties. The increase in the duty to 12.5% from 10% on July 5 caught gold traders and jewellery manufacturers off guard as some had been expecting the government to lower the tax instead. The Indian government wants to reduce its fiscal deficit as well as the trade deficit, and since gold is the second biggest import by value behind crude oil and fuels, it is an obvious target for increased taxation. While boosting the cost of gold to domestic consumers will lead to an increase in smuggling of the precious metal, it’s also likely that demand growth will take a hit.
The last time an Indian government raised import taxes, in August 2013, demand for gold jewellery fell sharply and took about a year to recover to previous levels. India’s gold jewellery demand fell 17% in the fourth quarter of 2013 to 138.1 tonnes, down from 166.6 tonnes in the same quarter a year earlier.
The next three quarters all recorded year-on-year declines in demand, and it took until the fourth quarter of 2014 for demand to recover, when it rose to 169.2 tonnes. Even if smuggled gold does replace some of the likely lost demand, the point is that Indian consumers face higher costs for their gold, and this is likely to crimp demand.
Gold recently reached a record high in local currency terms, hitting 99,666 rupees ($1,454) an ounce on June 25, although it has since slipped to end at 95,640 rupees on Monday. Since much of India’s gold purchases are for cultural occasions such as weddings, higher prices tend to act as a drag on demand. This is in contrast to China, the world’s top gold consumer, where price rallies often spur buying as investors seek to benefit from the gains.
The question for gold markets is whether any loss of demand in India will be enough to curtail the current uptrend, which has seen gold gain about 20% since the low of $1,159.96 an ounce on Aug. 16 last year to Monday’s close of $1,395.20. It’s unlikely that a slowing of India’s demand would reverse the current uptrend, rather it would take a combination of factors, but the problem for gold is that some of these may be falling into place.
Part of gold’s recent rally has been built around expectations that the U.S. Federal Reserve will soon cut interest rates, with easier monetary policy traditionally being positive for gold. But strong gains in U.S. employment have cast doubt on whether the Fed will lower rates any time soon, notwithstanding pressure on it to do so by President Donald Trump.
It may even be the case that Trump’s repeated calls for lower rates acts as a disincentive for the Fed to do so, given the board may not want to appear as if they are bowing to political pressure. There are still positive drivers for gold, including a weakening outlook for global economic growth and the unresolved trade tensions between the United States and China, as well as with several other major U.S. trading partners.
Exchange-traded funds have also seen rising purchases in recent weeks, with the largest, the SPDR Gold Trust, showing holdings of 25.62 million ounces on July 5, up from this year’s low of 25.57 million on May 15. Overall, what has changed with the India tax hike and the uncertainty over when the Fed will lower interest rates is that the overwhelmingly positive backdrop for gold has dimmed somewhat. That doesn’t mean further gains are unlikely, but it may mean they will be harder fought.