Can A 50% Duty Hike Dampen India's Passion For Gold? Not Yet!

The duty on Gold and Platinum imports was raised to 6% immediately from 4%. At 80%, Gold purchases are one of the biggest contributors to India’s current account deficit – the broadest measure of trade – which hit a record $22.3 billion ($A21.3 billion), or 5.4% of GDP, in the July-September quarter, as imports outpaced exports. Last year the Government of India doubled the duty on Gold to 4%. It is difficult to establish the impact (of the tax) on CAD and by how much it will come down, but there will be some moderation in Gold Demand.

“The duties will be reviewed after some time if there is a moderation in the quantity of Gold that is imported into the country,” Economic Affairs Secretary Arvind Mayaram said. The hike is part of a wider set of measures to improve the finances of Asia’s third-largest economy, which faces stubbornly high Inflation, a sharp slowdown in growth as well as the hefty current and fiscal account deficits. Domestic mutual funds, which offer gold-backed exchange- traded funds, will be allowed to deposit part of the Gold Bullion they hold with banks to boost availability for gold jewelry and gem making, Mayaram said.

The advantage will be that a part of the gold lying in stock will be brought into circulation and will partially meet the requirements of the gems and Gold Jewelry trade. It is hoped that consequently there will be a moderation in the quantity of Gold that is imported into the country. Finance Minister P. Chidambaram had hinted at an increase in tax on January 2, triggering a massive jump in gold imports. Gold shipments to India soared on mounting concern the duty would be raised. Expectations for the tax increase helped boost premiums in Asia by as much as 50% since mid-December.

There was a pretty clear sign that people were anticipating something was going to happen and trying to bring in some Gold beforehand. MCX Gold – Traded on the Multi Commodity Exchange ended up 0.6% at Rs. 30,757 after rising as much as 0.9% to Rs. 30,847 per 10 grams after the announcement. Ratings agencies have threatened to downgrade India’s sovereign investment rating to junk status unless the government takes steps to close the nation’s the deficits. The widening Current Account Deficit has increased India’s need for foreign capital inflows and evoked memories of the 1991 balance of payments crisis, when the Reserve Bank of India (RBI) sent 47 tons of Gold to Europe as collateral for a loan to avert a Sovereign Default.

Gold Import Duty Hike may not deter Buyers:
It is important to remember that, India’s Gold purchases are a major factor in the rise and fall in global Gold Prices. The passion and appetite for gold is so ingrained in India, it probably won’t have too much of a dramatic impact. In India, people have more belief that gold is the best commodity they can invest in. Gold buying is considered auspicious during religious festivals and weddings in India. The festival season starts in August and ends in November. The wedding season - and gold jewelry buying - is done during January to May every year. The increase in the import duty of gold is too small. The tax won’t impact imports and it will only help increase government’s revenue. India has long been the world’s biggest buyer of gold with purchases strongest during the religious festival and wedding seasons.

Last year’s rise in the import duty on gold dampened demand temporarily but purchases picked up again. Many Indians – especially in rural areas where there are few banks – purchase gold in the form of gold jewelry, gold bars and gold coins as a hedge against inflation. I strongly feel that the duty hike and government’s appeal to consumers to cut purchases might not help, largely due to the penchant for gold in India, the world’s biggest gold importer and gold guzzler. Fundamental reasons for buying gold – inflation and currency risks – remain as strong as ever. Industry analysts fear the increase in the import tax could spur smuggling across porous borders. Illegal trade was rampant before restrictions on gold shipments were lifted in 1990. India undoubtedly holds the largest chunk of gold reserves in the world, which needs to be mobilized.

The biggest - and idle - gold stocks are held by the large number of temples in India, which in valuation could run in trillions of dollars. If this stock is mobilized somehow, there would be a huge inflow of gold into the Indian Gold Market and the need for imports could largely be curbed then for a few years to come. This seems the only feasible way out to keep the Current Account Deficit in check and at the same time keep India’s gold appetite satiated. The other reason that I feel that gold imports may not decline as much as expected is that the INR may now start appreciating against the US Dollar, which in turn brings down the value of goods marked in Dollars. Gold Prices may not remain largely affected in India due to the duty hike as the same will be offset by the INR rise. So the Current Account Deficit may retain status quo.

Gold will get a Boost from the Japanese – Fed style QE:
The Bank of Japan today set a 2% Inflation target and said it will shift to Federal Reserve-style open-ended asset purchases in its strongest commitment yet to ending two decades of deflation. The BoJ will buy about 13 trillion yen ($145 billion) in assets per month from January 2014, including about 2 trillion in Japanese government bonds and about 10 trillion yen in treasury bills, it said in Tokyo today. The BOJ gave the price goal in a joint statement with the government.

Investors are the most bullish on Japan in more than three years as Prime Minister Shinzo Abe pledges aggressive measures to boost growth and weaken the yen. With the premier set to choose a successor for BOJ Governor Masaaki Shirakawa in April, the bank’s closer cooperation with the government and strategic shift in tackling deflation signal that more easing is ahead. Gold Demand can be expected to rise further in yen terms. Generally easing policies are positive for gold as it is part of the whole accommodative environment from global central banks.

Other Gold Price Influencing Factors:
The US Federal Reserve – FOMC policy meeting next week will provide clues on the central bank’s attitude towards monetary stimulus. Any indication of withdrawal of the policy could hurt Gold Bullion. Signs of progress in US Debt Ceiling talks can also help underpin gold. Gold may climb over the next three months as U.S. lawmakers attempt to tackle the country’s Debt Ceiling and the world’s largest economy slows, Goldman Sachs Group Inc. said, advising investors to place bets on advances. “We see current prices as good entry points to re-establish fresh longs,” analysts Damien Courvalin and Alec Phillips wrote in a Jan. 18 report.

The bank reiterated a three- month target of $1,825 an ounce, as well as a forecast for prices to weaken in the second half as the US Economy rebounds. Meanwhile, Allan Hochreiter Chief Executive Officer Rene Hochreiter, the top forecaster in the London Bullion Market Association’s 2012 poll, said, “The Gold’s bull market is over”.

The upcoming Lunar New Year festivities in Asia, particularly China, which is vying with India to become the world’s top gold consumer, have lifted physical gold demand since the start of the year.

Beware, while there is debate over gold - whether prices may rise or fall – silver may quietly rise and be the winner for 2013.