Increased Gold Imports lead to Rupee Depreciation & Current Account Deficit

So I wrote the post Round Tripping and the Ban on 23 & 24 Carat Gold Exports just yesterday. In this post, I talk about the practice of “Round Tripping” and how the Indian government hopes that its recent order banning gold jewellery exports of 23 and 24-carat purity will curb it to some extent.

For anyone who’s been reading recent news articles about this gold export ban and surging gold imports from South Korea (read about this in my next post The Recent Surge in Gold Imports from South Korea: the History, the ‘Why’ and the ‘How’ explained in detail) which have alarmed our government, it is only logical to ask “why all this fuss about gold?”

Here’s why.

India is amongst the top gold importers in the world. Roughly a quarter of the world’s gold demand comes from India thanks to our penchant for investment in gold. On an average (rough average over the years), India imports ~800-900 tonnes of gold annually. 

Gold imports comprised ~10% of our total merchandise imports for FY17 (note: gold imports were down 24% y-y in FY17). 

Since gold is paid for in dollars (USD), high gold imports tend to deteriorate our Current Account Balance. When this happens i.e. our imports become much greater than our exports, the demand for dollars rises as compared to that for the Rupee and the Rupee depreciates. 

Sustained Rupee depreciation is not a good thing for India. It makes imports expensive (each dollar costs more rupees now) and leads to inflation. Also since it tends to happen in concert with our Current Account Balance deteriorating (India always runs a Current Account Deficit since we are a net importer), it is accompanied by a fall in forex reserves with the RBI. This means a drop in our reserve of dollars, which we need to pay for our imports. This is always troubling for any net importer. 

Depreciation also worries foreign investors who’ve invested money in India since now their investment returns are lower when converted to their own currency. This may spook them and lead to an exodus of foreign money out of the country (called “capital flight”). This can crash our stock market and spike our bond yields, and lead to further depreciation of our currency. This would mean country-rating downgrades for India and basically a full-blown economic crisis. 

OK. So I described the absolute worst scenario there, but you get the idea.

Bottom-line

Gold imports form a significant portion of our import bill and hence have direct ramifications for our Current Account Deficit (CAD) and Rupee strength. Since gold is not a necessity for our economic growth in the way oil is, excessive import of gold, which deteriorates our CAD, is not desirable for our nation. This is why government bodies and market watchers keep a close watch on gold imports and this is also why you have been reading about them in the paper recently.