Higher gold prices in India are more a function of exchange rate

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Published: March 5, 2019 2:23:37 AM

Further, trade negotiations over tariffs between the US and China are underway and any movement therein will impact the currencies, which will have an effect on gold.

The Indian as well as the Chinese consumers generally decide their gold purchases based on their requirements and on the local price of gold.

Domestic prices generally follow international prices. This is also justified given the country’s near total reliance on imports for meeting its demand and as domestic gold mining is quite small. Even as the upward movement in the international prices is captured in the domestic price, the fall in international prices is not completely reflected in the domestic prices given that the Indian rupee has depreciated against the US dollar and also due to import duties which distort the local prices as compared to international prices.

As under normal circumstances gold and dollar share an inverse relationship, any weakness in the dollar pushes up gold prices and vice versa. The Indian as well as the Chinese consumers generally decide their gold purchases based on their requirements and on the local price of gold.

Gold prices

Local prices are different from the international price of gold due to the prevailing local demand-supply dynamics, regulations, import restrictions, seasonal factors and purity requirements. A surprising scenario emerges if the domestic prices in India are converted into US dollar prices and further controlled for import duties. The local gold price was broadly at a discount to the international prices from 2015 onwards. The local rate was at a discount to the international price for more than twice the number of days the price had a premium to the international rate (745 days of discount compared to 301 days of premium). Additionally, the premium/ discount was at opposite end of the exchange rate, i.e., when the rupee was weaker against the dollar, the local price was at a discount to the international price and vice versa. There seems to be minimal correlation between the exchange rate and the domestic gold premium/ discount. The local gold price was broadly at a premium to the international prices from 2015 onwards. The local rate was at a premium to the international price for more than 10 times the number of days the local price traded at a discount to the international rate (94 days of discount compared to 962 days of premium).

Demand and supply

So, the following two points can be theorised from the data. The higher prices in Indian market are more a function of the exchange rate rather the inherent price of the yellow metal internationally or demand.

Simplistically, lower prices seem to indicate lower demand for a commodity. Consumer demand for gold in India seems to be trending down justifying larger share of discount in local prices, while Chinese demand seems to trending up, indicating the likely reason for the premium in local prices for the period under review.

Due to the weakness in the rupee, India has a higher effective rate for gold with record prices being quoted in the domestic market. Additionally, general elections are scheduled between April and May of 2019, and a new government would take over mid-year. Consequently, demand may seem to be subdued with all this change in the cards. Further, trade negotiations over tariffs between the US and China are underway and any movement therein will impact the currencies, which will have an effect on gold.

The writer is chief economist, CARE Ratings. Edited extracts from ‘The Curious Case of Gold Prices in India’

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