Gold price fall may delay unwinding of import curbs.

The second half of 2014 hasn’t been great for commodities. The Reuters CRB Index, which represents a basket of commodities, is down 5% since the start of June with most of the fall being accounted for by oil prices. Brent crude is down 8% since then and that is great news for India, which imports 80% of its oil requirements.

In recent weeks, gold prices have started to correct as well. Earlier this week, gold futures hit a 10-week low and are now firmly below $1,300 per ounce at $1,271 per ounce. The stronger dollar has a large part to play in this fall in gold prices, which tend to move inversely to the dollar. The Dollar Index has been strengthening all summer and hit a one-year high this week.

The fall in gold prices, though, isn’t necessarily good for India. In the past, when gold prices have fallen sharply, gold demand from India has surged as India’s gold hungry consumers have rushed to take advantage of the lower prices. You only have to think back to last year to recall the surge in demand that accompanied a fall in global gold prices. In the April-June 2013 period, gold demand from India surged by more than 100% as prices fell steeply to near $1,200 an ounce levels. The surge was a key factor behind the current account deficit (CAD) hitting a record high and the currency falling to a record low. In the months that followed, India was forced to hike import duty on gold to 10% and attach conditions to the import of gold, which were akin to quantitative restrictions.

But all this is history. What makes the global gold price scenario relevant to India today is the fact that those restrictions on gold imports are still in place and lower global gold prices may actually make it tougher for India to unwind those curbs.

Looking at the recent CAD data, one could make the argument for normalizing gold imports. CAD stood at a relatively comfortable 1.7% of gross domestic product, or GDP ($7.9 billion), for the April-June 2014 quarter, far lower than the 4% seen last year. At the same time, foreign portfolio inflows have been strong, the balance of payments position is in surplus and the currency has been steady. On paper, it seems like a good time to start normalizing gold import policies.

But doing so at this stage could be a mistake. Here are a few reasons why:

First, while the April-June CAD was lower than the 4% CAD seen last year, it was higher than the 0.3% of GDP ($1.3 billion) reported for the January-March 2014 quarter. Sure, a seasonal moderation in exports played a role in the widening of the deficit on a quarter on quarter basis, but so did gold. In May, the Reserve Bank of India (RBI) took its first step towards unwinding some of the curbs on gold imports by allowing a wider set of agencies to import gold. The conditions linking the quantity of gold imports to gold exports were left firmly in place. Still, gold imports surged by 65% in June and the trade deficit in that month hit a 11-month high. This tells you that there is a fair amount of pent-up demand for gold imports, which could add very quickly to our CAD and push the rupee lower.

Second, all anecdotal and official evidence is pointing to an increase in gold smuggling. On 19 August, the Central Board of Excise and Customs (CBEC) estimated that gold smuggling had gone up seven fold in 2013-14. Separately, the World Gold Council estimates that 200 tonnes of smuggled gold will enter India this year. Reports from various news agencies suggest that gold smugglers are becoming more innovative. A 13 August Wall Street Journal report said that gold dust is being mixed with henna powder and chocolate! About the same time, Reuters reported instances of Special Economic Zones being used for gold smuggling. All this suggests that smuggling is on the rise and lifting curbs would push at least some of this demand back to official channels relatively quickly.

The third factor is a combination of timing and pricing, and this brings us back to the global markets. The September-December quarter is usually a quarter in which demand for gold picks up because of festival demand in India. Given the recent correction in gold prices, demand may get bunched up as consumers try and take advantage of the reasonable prices.

Where does that leave us? It leaves us in a situation where we have no clear idea on how and when the government and RBI will unwind restrictions on gold imports. And until that is done, we won’t have a clear idea on how much our current account situation has really improved. So let’s hold off on popping that bubbly just yet.

Source : livemint.com