Plunging gold prices are a godsend for India’s teetering economy. Inflation at a three-year low is an additional manna. The man-made bonus is a slowly improving fiscal position. Dare one think India’s fundamentals are at last set to retreat from their precarious edge?
The respite for the current account deficit, largely expected above 5% of gross domestic product (GDP) for 2012-13, is doubtlessly enormous ahead. Gold prices have fallen 24% from their peak level in dollar terms and are 16% lower over their value in the first week of October last year; in that quarter, the deficit swelled to $32.6 billion (6.7% of GDP) from gold imports of $6.4 billion.
The sudden tumble in gold prices has increased future uncertainty and dampened the speculative lust: gold imports, which fell 24% in January-March, are reported dropping at a similar pace in April, according to Bombay Bullion Association; exchange-traded funds are selling fast to limit losses, an estimated 400 tonnes of June gold futures are reported put up for sale (gold imports were 200 tonnes in the first quarter of 2013), while jewellers have temporarily shut shop. A simultaneous drop in wholesale price inflation to 6%, with 3.5% core inflation, helps by increasing real returns on alternate assets. All this helps the current account deficit and lowers external financing risks.
The question is whether this bounty will last, and for how long? Unlike oil and commodities, which are tumbling too, gold is a safe haven—a hedge against money debasement; it benefits from quantitative easing, or low interest rates, high liquidity, dollar weakness and risk aversion. Its fall is driven by gathering investor perceptions that the US economy has turned, several European central banks may be looking to encash gold reserves and the gold cycle is coming to an end. Broader trends in commodities, including oil, are echoing this pattern. Here, an energy-sufficient US and below-expectations GDP growth in China is leading to investors anticipating that the long-running, commodity supercycle from the 1980s is finally coming to an end. Forecasts by all international agencies expect these prices to remain subdued in 2013.
These trends could be a mix of short and medium-term positives for an import-dependent economy, over whose beleaguered fundamentals hangs a cloud of political uncertainty. When the frequency of political wobbles is increasing fast, there is lesser the government can do each passing day. Nonetheless, it can still channel this unexpected bounty into uplifting growth which is currently running below 5%. The rapid pace at which global asset re-pricing is taking place, for instance, increases exchange rate uncertainty; not just in the immediate context, where a risk-off sentiment is keeping the rupee weak, but its value few months down the line and beyond.
Where the exchange rate is headed then is the critical question in businessmen’s minds. Will a sudden turn in sentiment to risk-on translate into a stronger rupee? Or will it stay competitive and excess inflows purchased to boost reserves? With oil and commodity prices in benign mode and gold demand coming off, a rethink on exchange rate management—to keep the rupee stable in line with its fundamentals—would serve the economy well at this point.
Renu Kohli is a New Delhi-based macroeconomist; she is currently lead economist, DEA-Icrier G-20 research programme and a former staff member of the International Monetary Fund and Reserve Bank of India.