scorecardresearch
RBI's gold import restrictions: Right diagnosis, wrong treatment

RBI's gold import restrictions: Right diagnosis, wrong treatment

A hike in import duty can only be a short-tem solution to clamp down on the demand for the yellow metal when its prices are coming down.

Mahesh Nayak
The Reserve Bank of India (RBI) has correctly diagnosed the root cause of both the rising current account deficit (CAD) and the weakening of the rupee: India's insatiable appetite for gold.

But the same cannot be said of the treatment it has chosen to cure the ailment. It has imposed restrictions on gold imports, the largest item on India's import bill after crude oil.

Market experts feel the restriction will reduce gold imports by about 10 to 15 per cent. This may not necessarily impact the demand for gold. Also, retail investors in gold, who are responsible for the gold consumption during the festival and wedding seasons, will largely depend upon jewellers for their purchases.

Exporters, who order the quantity of gold requirement through banks will continue to get as much gold as they want provided they use the Letter of Credit route and pay for margins ahead of delivery.

How will the curbs affect gold prices?

"The situation will depend on the time-frame," says Naveen Mathur, Director at Angel Broking. "In the short-term, the trend in gold prices will be determined largely keeping in mind the monetary policy developments in the US. With expectations of a pullback in bond purchases, the Dollar Index is expected to strengthen, thus leading to pressure on gold prices. An easy US monetary policy has been a key factor in pushing gold prices higher and a reversal of the same would cause havoc in the global markets."

With gold prices coming down, demand is expected to rise. It has been seen in the past that a hike in import duty is a short-term solution. In the medium to long-term consumers come back to the market.

In May 2013 itself gold imports stood at 162 tonnes, higher than the 153 tonnes clocked in the entire first-quarter of the last fiscal year. Gold imports by India stood at 860 tonnes in 2012. The World Gold Council expects the country's gold import to touch a record level at 300-400 tonnes in the April-June period.

The flip side of restrictions will be increased gold smuggling and increased grey market activity. In short, the RBI's move on gold prices is expected to be limited on prices and demand, considering the variety of factors affecting gold prices internationally.

An immediate reaction to the curbs has been the rupee moving up from its 11-month low, but this can't be the right way to shore up currency.

Be it during the Asian crisis of 1997/98 or the Argentinean peso crisis of 1999/2002, no central bank in the world could ever control the movement of currency.

With foreign institutional investments in Indian equity at historical high of over 2.5 per cent of market cap (anything over two per cent of FII investment in stocks has triggered selling), the sword of Damocles (of their withdrawal) will always hang over Indian markets which will further put pressure on the currency.

Following expectations of the withdrawal of stimulus measures by the Federal Reserve, the dollar has strengthened against other currencies across the globe including the Indian rupee and any pressure in the equity markets will put further pressure on the Indian currency.

Agrees Vikram Dhawan, director of Equentis Capital, who says: "Micro managing the currency is not the right approach. Our only hope is a macro correction and a structural correction that will automatically make imports costlier and discourage demand."