With the Indian rupee plumbing new lows against the US dollar and the country’s current account deficit at record levels, the Reserve Bank of India (RBI) is taking the easiest route to tackle both; it has declared a war on gold. Our Chart of the Week shows the Indian current account deficit from 1970 to the end of 2012. As you can see, it has hit a record deficit level and continues to weaken. Put simply, a current account deficit occurs when a country's total imports of goods is greater than its total export of goods; this situation makes a country a net debtor to the rest of the world. India is the largest consumer of gold, almost all of which is imported and is a significant contributor to this deficit.
The RBI has drawn the battle lines and targeted gold imports as the main culprit. The central bank has announced a series of measures over the past month, including restraining lending against gold-backed assets, and restricting gold imports. The hike in gold import duty to 8% this month is the most recent announcement in this drive and doubles the duty that was applied at the beginning of this year.1 The RBI has asked bank trading houses not to import gold on a consignment basis for domestic sales, further insisting on 100% cash margin for letters of credit. The restrictions were invoked after imports soared to 162 tonnes in May from 142 tonnes in April on the back of weak international prices. In their campaign against gold imports the Indian finance minister P. Chidambaram has even urged banks to advise their customers not to invest in gold. “I think the Reserve Bank has advised banks that they should not sell gold coins,” said Chidambaram, while speaking at an event in Mumbai.2
Gold is synonymous with savings and security for many of India's 1.24 billion people. Only about 36,000 of India's 650,000 villages have a bank branch, which mean the working class hold much of their assets in gold coins and jewelry. Further increasing demand is gold’s cultural significance which makes it essential for weddings and other ceremonies. We suspect that there is very little the RBI can do to supress the consumption of gold and the central bank’s efforts will serve only to push the gold trade underground through smuggling and off-shore trading centres.
Source: Bloomberg, Sprott Asset Management LP
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