The economic logic of making gold pricier

India produces very little gold and consumes a lot of it. In FY21, the domestic production was just 1,127 kg. In comparison, gold imports were at 651,240 kg. This shows the disconnect between the demand and the domestic supply. In April and May, 139,943 kg of gold were imported, 7.4% more than in the year-earlier period.

In absolute terms, $7.78 billion was paid for this imported gold, an increase of around 11.8% compared to April-May 2021. While June’s data isn’t available yet, it is quite possible that gold imports might have gone up compared to last year. Gold is seen as an inflationary hedge, and typically, people tend to buy more of it when inflationary expectations are high as they are currently.

This has other effects. Gold is bought and sold internationally in dollars. Hence, imported gold has to be paid for in dollars. This increases the demand for the dollar and leads to the rupee’s depreciation. Of course, gold import is not the only thing that is putting pressure on the rupee. There are other factors as well.

The foreign institutional investors have net sold stocks worth $33.6 billion between October and now. Due to the war in Ukraine, the price of commodities like oil, coal and fertilizers has gone up. This has led to a higher import bill for these commodities and, in the process, higher demand for dollars. Further, between January and May, the non-oil non-gold non-silver goods imports stood at $188.4 billion, up almost 32% from a year earlier.

All these factors, along with higher gold imports, have put pressure on the value of the rupee against the dollar. The government cannot limit higher oil imports. At the same time, even a hint of preventing foreign institutional investors from selling stocks and repatriating money will only lead to a further fall in stock prices. In this scenario, the government is doing what it can do. One step has been increasing the import duty on gold. Given its high price, gold, unlike silver, has very few industrial uses. The idea is that the higher import duty will make gold more expensive. Higher prices will hopefully dampen demand and, in the process, help control the demand for dollars and the trade deficit.

Along with this, the government has also imposed cesses on the export of petrol and diesel. The cesses amount to ₹6 per litre on petrol and ₹13 per litre on diesel, respectively.

The hope is that this will increase the domestic supply of petrol and diesel and lower the import dependency on oil and its products.

The import dependency on oil consumption jumped to 86.4% in May. It was at 85.6% in 2021-22. With an increase in domestic supply of petrol and diesel, this dependency is expected to decline, lowering demand for dollars and the pressure on the value of the rupee.

To conclude, a weaker rupee feeds into retail inflation, but there are other repercussions. For example, the government offers a fertilizer subsidy to farmers. The total fertilizer subsidy bill for April and May stood at ₹10,778 crore, or around 58.4% more than in the year-ago period. Of course, fertilizer prices have gone up, but at the same time, the rupee has also lost value against the dollar, which has added to the fertilizer subsidy bill.

Given these reasons, the central government is taking steps to slow down the depreciation of the rupee against the dollar.