Can the Indian demand for gold be curtailed? Imports of gold stood at around 25-30 tonnes in the first week of January according to a report

There are expectations that the government may increase the import duty on gold to reduce the pressure on the external account, but the Indian love for the yellow metal is likely to remain strong because of age-old traditions, and the perception that it is a hedge against inflation and weakening rupee.

Imports of gold stood at around 25-30 tonnes in the first week of January according to a report by Wall Street Journal India, after Finance Minister, P Chidambaram said that government was considering measures to make gold imports costlier after the current account deficit climbed to an all-time high of 5.4% of GDP in the December quarter. Economists expect the current account gap at 4.3% in FY13, with gold imports making up around a third of the external balance.

“Jewellery demand is already up 25% year-on-year in the first two weeks of January, although the beginning of year is not considered very auspicious for gold buying,” said Mehul Choksi, chairman, Gitanjali Gems Pvt Ltd. The demand for the yellow metal is seen mainly from non-resident Indians who are buying jewellery because of the depreciating rupee which has fallen 5.4% in the past one year. “Even if the government hikes the import duty by 1-2%, jewellery demand is expected to remain strong. In the last 15-20 years, Indians have become rich because of stocking jewellery,“ reckoned Choksi.

Bullion analysts expect gold imports at around 750-800 tonnes in 2012, down from a record high of 959 tonnes in 2011, even though the government raised the import duty on gold to 4% at the beginning of last year. “An Indian family member will still gift 10 grams of gold to a relative who is getting married, even if prices go up,” said Bhargava Vidya, a senior gold consultant from B N Vaidya & Associates.

It will be difficult to wean off Indian consumers from a 2000-year-old tradition of buying gold, by raising taxes, because there are not too many alternatives to gold which has given steady returns since 2008. Gold has doubled, while equity markets and bonds have given tepid returns since the beginning of the Lehman crisis. Gold is also seen as a hedge against inflation which has remained stubbornly high. Investments in gold have also protected investors from a depreciating currency. Election funding ahead of next year may buoy gold demand as political parties try and get funds from overseas in the form of imported gold to take advantage of a falling rupee and rising gold prices in dollar terms, said Sanjiv Arole, an independent bullion analyst.

Moreover, it is well known that increasing tax on gold may only pave the way for the Midas metal entering the country via the black market which was the case last year. Unofficial gold imports tripped to $169 million between April to May in 2012 after the government increased the import duty on gold to 4% from nearly flat.

Even globally, the demand for the yellow metal is expected to remain strong. GFMS, a precious metal research firm based out of the United Kingdom in an email said, “Our forecasts are for gold price to test $1915 this year as loose monetary policies are expected to remain in place and gold as a risk hedge. Expectations for higher prices will buoy demand and could push investment demand to a new record high in 2013.” Globally, investors have been pouring money in gold-backed exchange traded funds and over the counter products following loose monetary policy in Europe and United States.

Are there any alternatives?

While the Reserve Bank of India in a draft report of the Working Group to Study the Issues Related to Gold on 2 January, has suggested inflation-linked savings scheme and gold-linked financial products to curb imports, financial penetration in India is still around 50%, and it may not be an easy task to implement such schemes.

Arole suggests, “There is no use only flogging gold to address the current account deficit. One should look at subsidies seriously if one wants to tackle the trade deficit.” But again politically, it is not a viable decision ahead of elections next year and gold remains a soft target for the government.