India Trying to Axe Gold Imports with Another Duty Hike

India is launching another attack on gold imports in an effort to slash its bulging current account deficit. The tactic — hiking the country’s import duty rate — is one the government has used before. This time, the rate was increased from 4 percent to 6 percent.

At the beginning of the year, India’s finance minister, P. Chidambaram, warned that the duty on gold imports would likely be raised, Reuters reported. On Monday, when the news broke that the decision had been finalized, the impact on gold prices was immediate.

“Gold prices shot up by Rs 315 [approximately US$5.86] to Rs 31,250 [$581.78] per 10 grams and markets sources say it may go up to Rs 700 [$13] per 10 grams in the short term,” an article in The Financial Express states.

India has gone from a flat rate — which amounted to about 1.1 percent of gold prices at the end of 2011, according to a report by GFMS analyst Sudheesh Nambiath — to the current import duty of 6 percent in the span of year.

Indian gold demand in 2012 proved to be a disappointment for many market participants. The year began with expectations that India would be in tight competition with China for the title of world’s largest gold consumer, but ultimately India was a weak competitor.

With a year to adjust to the new reality, some foresaw Indian demand making a healthy comeback in 2013. But the Indian government has now made the metal even more expensive, and there is a lack of consensus as to the impact that this action will have.

“The hike in duty will only lead to large scale smuggling and loss of revenue for the government. An increase of Rs 60 per gram will not drive away imports,” said Mohit Kamboj, president of the Bombay Bullion Association (BBA).

The Economic Times reported that investors are brushing off the tax hike, while industry officials expect only a moderate drop in demand. Traders believe the move is already priced into the international market and they too are looking for the rate increase to be largely offset by increased smuggling.

But others have looked to the past to offer insight, and they see the possibility of a more notable impact on Indians’ appetite for gold.

Jewelry demand in India fell 11 percent last year, according to Societe Generale, which believes that the decline could have more to do with fears of a weak monsoon season and volatility in gold prices than with tax increases.

However, the firm also pointed to small bar demand, which usually steals market share from the jewelry sector in times of uncertainty or rising prices. But last year, demand for that product also dropped by 26 percent.

“The fact that bars lost market share to jewelry in the first part of last year could well mean that this was a direct reaction to the increase in import tax rates. Indian demand for small bars could therefore be affected again this year in the wake of the government’s latest move,” the firm said.

“It is possible that there will be a strong impact on the overall market due to these changes, as India accounts for approximately 28% of world small bar demand, but we believe that last year’s contraction is unlikely to be repeated,” Societe Generale added.

While the Indian government clearly believes that import levels are still too high, according to Nambiath, demand is not increasing — rather, it is decreasing.

From April to September, after the gold import duty was hiked to 4 percent, imports declined by nearly $10 billion compared to the amount of inbound shipments seen during the same period in 2011. Volumes declined by 37 percent, according to GFMS.

“In our view, this already presented a clear sign that the Indian consumers’ response to policy changes has been to curb their expenditure on gold,” Nambiath’s report states.

Indian investors’ buying power must also be considered. Some like to portray Indians as having an unwavering affinity for gold, but the rupee’s weakness was an aggravating factor for weak Indian gold demand in 2012. When the rupee declines against the dollar, the currency in which gold is priced, it adds more expense to metal purchases.

The wedding season kicked off this week. Due to a weak rupee, however, gold importers have reportedly been backing away from deals in spite of the fact that we are now in what is supposed to be a season of strong demand.

Furthermore, even if the latest duty hike only leads to a moderate decline, as some suggest, viewing that result in isolation may present a skewed portrayal of the situation. More significance may be derived by viewing a dip in imports as being additional to declines that have already occurred.

India’s gold demand of 963 metric tons (MT) in 2010 fell to 933 MT in 2011.

Kamboj said gold imports in the first three quarters of this fiscal year, which ends in March, amounted to 600 MT. This quarter, the BBA president is only looking for imports of 100 to 150 MT, bringing the annual total to about 750 MT at best.

Now, there is the potential for further declines — even if moderate — in 2013.

 

Securities Disclosure: I, Michelle Smith, do not hold equity interests in any companies mentioned in this article.

Related reading: 

Will India Remain the Largest Gold Consumer in 2012?

Is India’s Appetite for Gold Declining?