The Reserve Bank of India’s (RBI’s) ban on banks advancing loans to finance gold purchases in any form is not surprising. Increasing gold demand triggers alarm bells over India’s current account deficit.
According to World Gold Council data, demand for gold in India is recovering; it had remained subdued in the June quarter after the government doubled the import duty on the precious metal.
Total gold demand grew 9% from a year ago to 223.1 tonnes in the September quarter, driven by both jewellery and investment demand. Indeed, the latter grew a strong 12% despite prices rising to a record in September leading the council to say that Indians have “acclimatized to recent price trends and have been buying into a rising market”.
Although a seasonal rise in gold demand is to be expected, the direct fallout is a worsening of the current account deficit. It is already evident in the trade deficit figures for the past couple of months. The trade deficit in October widened to an all-time high of $21 billion (around Rs.1.2 trillion today) as a weak trend in export growth was compounded by the familiar factors of gold imports, higher oil prices and even higher non-oil and non-gold imports.
With the trade deficit in July-September at $50 billion compared with $39 billion in April-June, pundits are forecasting the current account deficit to touch 5% of gross domestic product in the second quarter. That is well over the 3.9% recorded in April-June. What lends credence to these forecasts is the subdued performance on the invisibles front and the muted growth in the export revenues of software companies in the second quarter.
Where does this leave the rupee?
After rallying a bit in September on announcement of reforms such as opening some sectors for foreign direct investment and easing of the rules for external commercial borrowings, the rupee has been testing two-month lows. After the initial impact of QE3, (third round of quantitative easing) foreign inflows too have been easing as can be seen from the November data. With the economy not getting any better, it is difficult to see flows surging again and the rupee reaching the 52 mark by the end of the year as forecast by some economists.
As Religare Capital Markets Ltd sums up in a recent note: “Government expectations on reaching the 50 mark is only possible on heightened risk-on or surprising reforms, both of which we believe are unlikely for now.”