Lower gold price as CAD cure gets a rethink

Mumbai: There aren’t too many takers any more for the theory that the crash in gold prices will solve the problem of a record current account deficit (CAD) in Asia’s third largest economy.

add_main_imageAlready, from this month’s low of $1,347.95 per ounce (28.35g), international prices have risen 8.88%. In the domestic market, gold prices have recovered 6.58% after hitting a low of ₹ 25,695 per 10g on 17 April.

As far as Indians are concerned, the timing of the crash in gold prices couldn’t have been better. Why? Because there’s always a wedding season round the corner.NextMAds

“There has been a 30-45% increase in sales in the current season due to the combined impact of the price crash, and the arrival of festive and wedding seasons,” said P.P. Jose, executive director at Joyalukkas India Pvt. Ltd, a Kerala-based jewellery chain with 85 outlets around the world.

The surge of buying has been such that “we have stopped the long-term, advanced bookings for gold ornaments”, he said.

Such bookings involve customers paying around 50-60% of the value of ornaments at prevailing prices for purchase at a later date.

Jewellery shops are discouraging the practice, because they are jittery about prices rising even further. If that happens, advance bookings will lead to the jewellers making losses.

Analysts are adding voice to the growing scepticism about gold imports being reined in, and therefore CAD, thanks to the drop in prices.

A fortnight after domestic rating agency Credit Analysis and Research Ltd (CARE) expressed its doubts about falling gold prices helping to lower CAD, Hongkong and Shanghai Banking Corp. Ltd (HSBC) said much the same in a research report on Monday. Falling prices will actually result in more demand for the yellow metal, HSBC said.sixthMAds

“The recent fall in gold prices has lifted hopes of a drastic narrowing of the CAD. However, the price drop will also raise Indian’s demand for gold; our model shows high price sensitivity of demand,” Leif Eskesen, chief economist for India and Asean (Association of Southeast Asian Nations), and Prithviraj Srinivas, economics associate at HSBC, said in the report.

“The price drop should, therefore, have little impact on the deficit, while lower inflation and wage growth matter more,” the HSBC economists said.

International gold prices crashed to a 26-month low in April following speculation that Cyprus planned to sell its reserves of the metal to tide over its financial crisis. Subsequently, the Cyprus central bank denied any such move.

On Monday, international gold prices were trading up by 0.85% at $1,474.58 per ounce.

Experts had previously suggested that the drop in the price of the metal would help India curb the fiscal deficit, arguing that lower prices would reduce the appetite for the commodity.

But that logic applies only when the metal is seen purely as an investment. It doesn’t seem to work in India, with more than half of gold imports used to make ornaments for weddings.

“Indians buy gold for consumption purposes, with customary gifting of jewellery. Owning gold also raises social status. It, furthermore, has been traditionally used as a savings instrument in rural areas with a lack of banking penetration, and is also bought for investment purposes, having offered good real returns,” HSBC said in the report.

A widening CAD, mainly due to higher gold and crude oil imports in recent years, has been a major concern to Indian policymakers.

India’s CAD widened to 6.7% of gross domestic product in the December quarter.

In the 12 months ended December 2012, total gold demand in India was 864.2 tonnes, down 12% from 986.3 tonnes a year ago, according to the World Gold Council. In value terms, demand declined 5% to $46.5 billion.

In a 17 April research note, rating agency CARE said falling gold prices were unlikely to curb demand and hence would not have a positive impact on CAD. “At lower prices, given traditional India’s penchant to hold gold and with the seasonal demand round the corner, there could be an increase in physical demand, which would compensate for the lower price effect. Therefore, it needs to be seen whether or not overall imports would be lowered in dollar terms,” economists at CARE said.

The Indian government and the central bank have been trying to curb gold imports by introducing alternative financial products that offer equal returns. However, these efforts are yet to yield results.

According to the HSBC report, the rise in gold imports following the global financial crisis in 2008-09 was driven by strong real wage growth, especially in rural areas. That apart, rise in inflation and, consequently, the erosion of real returns on deposits also encouraged more gold buying, it said.

“In fact, the volume demand for gold is price sensitive, and we, therefore, find that the recent drop in gold prices is likely to have no impact on the current account deficit as the drop in prices should be outweighed by a rise in volumes. The expected decline in inflation and real wage growth should, however, help narrow the CAD slightly,” the report said.