What India Did to the Gold Price

How India's anti-gold import rules are affecting the gold price...

 

THIS YEAR the Indian Government raised import duties as high as 15% on gold, writes Julian Phillips at the GoldForecaster.com.

 

India then prevented the import of gold unless 20% of that gold was exported. What impact has this had?

 

The stated aim of these measures was not to interfere with the price of gold, but to reduce the Current Account Deficit. We know that these measures will only work in the short-term because smuggling will replace the import deficit of gold and the government will have to bow to pressure from the voting public ahead of May elections.

 

The average Indian family expects its government to misgovern and tolerates the corruption from the highest to the lowest levels, including from the bureaucrats appointed to impose the laws, particularly on gold. Because of this, the Indian business culture is very private and uses black money or an "alternative financial system" to avoid government eyes.

 

In the last century, there was a period when gold imports were banned and the system for smuggling was well developed. Gold continued to come in from Dubai and across the long coast of western India. Boats would meet the fast speedboats with silver and exchange it for gold, thus avoiding risks on the Rupee. In addition, the long land borders of India facilitate smuggling.

 

Today gold smuggling has become far more sophisticated, using most of India's borders. We can only roughly guess the volumes being imported this way, but it's now so large that the smuggled gold market is selling gold at a $50 discount per ounce to the legal gold market. The legal gold market has already lost a third of its turnover and stands to lose far more as smuggled volumes of gold rise.

 

The Indian government is fully aware of this, but the advantage of taking such a line is that the official Current Account Deficit will fall while unreported imports of gold avoid adding to it. The CAD will in reality rise still but be off the books. This too is a 'manipulation' of the gold price as pent-up demand adds to the premiums being charged. Premiums in India have recently risen as high as $264 or 21% an ounce of gold, before falling back but holding at $150.

 

Let's be clear on this, after a superb Monsoon, the Indian farming community has reaped bumper harvests and is hungry to buy gold. As a result, Indian demand is higher than ever before, but the supply isn't there – they're starved of gold.

 

So what's the Indian government's next move? The next election is in May 2014, and they cannot afford to be seen as responsible for the destruction of the country's gold industry; it would lose far too many votes. Right now there are increasing pressures to soften the gold blockade. Expect a change as soon as the government thinks a change might gain more votes.

 

The government has to tread carefully because there's an impending 'reserves' crisis, as its indebtedness relative to reserves becomes critical. The latest numbers out of India show that growth has slowed – it needs 8% growth levels but is only achieving around 5% now – and inflation is moving up over 8% and more. Its current account deficit is not solved by blocking gold imports, but this helps.

 

The current account deficit does open up India to a precipitous drop in the exchange rate of the Rupee. The Reserve Bank of India is fully aware of this too, so there's a need to find support for their currency. As a sign of the measures they may take to ensure that foreign currencies are always available to them, they have already made exploratory moves to see what gold they can 'harness' to support the Rupee. Their prime target is India's temple gold. Owning some 2,000 tonnes – part of around 25,000 tonnes held inside India already – the temples hold a lot of it stored in banks. This makes it even easier for the government to harness it for their own purposes. Because it sits in banks the same as all deposits do, i.e. as unsecured loans, there will be no need to officially confiscate it. They'll have control of it simply by agreeing to "loan" it for an extendable period.

 

There is no doubt that the Indian government could harness locally-owned gold. The currency would then be the best-backed currency in the world and wouldn't suffer declines if its gold were used as collateral for its foreign currency needs.

 

When this happens, we see it as very positive move for the gold price, and by extension, the silver price. But this may have to wait until after the elections next May because of the expected anger it would cause amongst Indian voters.

 

The point is that governments can act directly to manipulate gold prices inside their country, whether to its detriment or advantage. And India's blockading of gold imports has prevented the gold price from reaching a market accurate price.

 

The absence of direct Indian demand is also holding down the US Dollar price of gold. It's preventing global demand from overtaking global supplies, thus stopping the gold price from returning to record highs.

 

India could well be among the first countries to take citizen's gold to support their currency but certainly not the last; it will monetize its gold to some extent and provide a preview of what's to come when the Chinese Yuan becomes a reserve currency.