India’s trouble with gold demand

Recent data released by the commerce ministry shows that gold import has grown four times over a period of one year. Imports rose from $1.09 billion in October 2013 to $4.14 billion in October 2014. In terms of quantity, import surged to 150 tonnes from 24 tonnes, resulting in a widening of the trade deficit to $13.35 billion from $10.59 billion in October last year.

Gold is the second commodity after oil which contributes significantly to the widening of the current account deficit in India. The surge in bullion imports has negated the benefits of a lower oil import bill due to a fall in international crude oil prices.

India is one of the largest importers of gold globally. As much as 90% of the country’s gold demand is met from import as indigenous production of gold as a proportion of India’s total demand is very limited. Gold is also considered an attractive investment option in India even if as a commodity it does not add much value to the productive capacity of the economy. An additional factor is its universal acceptance as a liquid commodity and a hedge against financial or economic turmoil. To curb the high import demand for gold—that bloated India’s current account deficit to a record 4.8% of gross domestic product in 2012-13—the Union government raised the import duty on gold from 2 to 10% over two years. In August 2013, the 80:20 rule was introduced by the Reserve Bank of India (RBI) to further restrict import. Under this rule, nominated agencies were allowed to import gold on the condition that 20% gold would be exported. Recently, RBI withdrew this scheme apparently due to a rise in smuggling of gold and loss of revenue to the exchequer.

As is evident from import data, import duty increases, along with the 80:20 rule, have been successful in suppressing gold import temporarily. But long-term import dynamics are unlikely to be affected by such ad-hoc measures. One answer to this problem could be to estimate gold import demand elasticities, both in the short-term and long-term. We have empirically estimated short-run and long-run elasticity of gold import demand for India with respect to real income and real price of gold.

Our analysis finds that the long-term elasticity of gold import demand, with respect to real income is greater than one. Even though price elasticity of gold import demand is highly elastic in the short-run, it is inelastic in the long-run.

This implies that increasing the price of gold will be effective in restraining gold import demand but the effect will be short-lived. Reduction of gold import demand in 2013 indicates that the import duty increases and other measures adopted by the government to reduce gold import demand in the first and second quarter of 2013 have started having their effect. This also supports our empirical finding of highly elastic short-run price elasticity of gold import demand. The long-term price and income elasticity estimates also suggest that gold import is bound to increase after some time again.

The recent surge in gold import, along with rampant gold smuggling, is a pointer in that direction. Inelastic gold import demand with respect to its price indicates that gold is an inevitable choice of investment in the absence of better investment substitutes. The Union government has re-launched the Kisan Vikas Patra scheme hoping to lure investors away from gold. That should appeal to the unbanked population in rural areas but may not be sufficiently attractive for urban investors as there are other fixed income products available that offer higher returns.

Only time will tell the fate of the scheme which is aimed at controlling gold import and reducing the burden of trade deficit due to India’s unquenchable thirst for gold. Restrictions on gold imports are unlikely to work.

Kakali Kanjilal and Sajal Ghosh are, respectively, on the faculty of IMI, Delhi and MDI, Gurgaon.

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