Globally, gold prices have slumped and that has made P Chidambaram, the finance minister, extremely happy. The reason: the combination of low prices, high import duty and relaxed baggage rules, according to the FM’s logic, would lower the overall value of the precious metal imported by Indians. Logically, India’s total imports would come down, which could reduce the country’s current account deficit (CAD, or the difference between imports and exports).
CAD has hung like a Damocles’ sword over Chidambaram’s head for a long time. The global credit rating agencies have pointed to the high deficit as one of the problem areas. If the FM could control CAD and fiscal deficit, which he promised in Budget 2013, it would reflect well on him. And prevent the rating agencies from downgrading the country’s rating to ‘junk’ status. As has been speculated in the media, such achievements could help project Chidambaram as the PM candidate in 2014.
A contrarian view, however, is that the FM may have celebrated too soon. All his calculations on gold imports and CAD could easily go wrong in the near future. This is because trends over the past decade prove that each time global prices of the yellow metal have eased or remained relatively stable, demand has surged, especially in India, which is among the largest consumers. This has happened several times in the past 10 years, and is likely to be repeated again.
The buying frenzy is already visible. Indian consumers, who had postponed their purchases because of the high prices, have queued up outside the jewelry shops. Most individuals one speaks to these days only talk about spending their money to buy gold. “Thank God, I didn’t buy it in December 2013. Now, I will save Rs 100,000 on the quantities I wanted to purchase,” said one of them. If this trend continues, Chidambaram may find himself in a new, and deeper, mess.
But first, let us see what happened in the past when gold prices did come down. In 2004, they dropped from $425 in January to $375 by May, only to rise again to $425 by October. Since the prices during most of the year were either down or at the same level as in January, demand surged. In 2008, global prices crashed from $1,000 in mid March to $713 by end October. Although they were up to $870 by the end of the year, consumers bought more gold like there was no tomorrow.
The year 2011 was different. Although the prices of the yellow metal remained high, they slumped from $1,895 in early September to $1,531 by the end of the year. Since September-December is the peak buying season, overall annual demand shot up. In 2005, when prices remained relatively stable, and fluctuated between $414 and $450 through the year, demand was high. When prices consistently shot up in any year, like in 2009 when they zoomed from $810 to $1,200, demand slumped.
Therefore, it might be logical to presume that demand would increase this year because of low prices. If this happens, the value of gold imports could be higher in 2013-14 compared to the previous year. Other imports, especially fuels, which form the bulk of total imports, could also increase as the economic growth this year could be higher. Since, exports might not grow in 2013-14 – in fact, they have shown negative growth rates in recent months – CAD might go up, rather than come down.
Chidambaram would then find himself in a policy bind. As he has said recently, if he tried to curb gold demand through higher import duty, it could lead to smuggling as the differential between global prices and landed cost of gold would become substantial. If he left it to the market forces, CAD would go up and the global rating agencies could get ready to fire their downgrade salvos. Either ways, the Damocles’ sword would continue to hang on its last thread over the FM’s head.