India's Gold Dilemma Impacting Global Market Sentiment

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For Part 1 of this article, read yesterday’s post

The Indian government could be said to be on top of the economic situation, considering that the currency has recovered a little and the deficit reduced somewhat. But this is against a backdrop of low-interest-rate, easy money supporting emerging market investor sentiment.

As we saw when the Fed first mooted a reduction in taper relief earlier this year, shock waves reverberated around financial markets, especially in emerging market debt. The Reserve Bank of India (RBI) is acutely aware of their precarious position and has proposed a scheme called the Rashtriya Swarna Scheme, which is intended to help the country (read: the government) to reduce gold imports and seek alternative sources of supply.

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Ashok Minawala, a past chairman of GJF, is quoted as saying that “eligible jewelers will work as nominated agents of the Bank and will help collect unused and idle gold from households and temple trusts. In three years, we can help mobilize 1,000 to 1,500 tons of unused/ idle gold and make India free from importing gold for domestic consumption. Customers can deposit their unused/ idle gold on the spot and the gold is held in their demat accounts while they continue to earn interest in gold or rupee terms.”

The idea has a certain logic. But it’s is already raising fears that gold held in bank vaults will be seized without agreement or proper interest. There is an estimated 25,000 tons of gold held privately in India, and the temples hold a significant percentage of that. If the government were to make a move on those reserves, it would cause an uproar. But for a country struggling to maintain its international financial standing, one could understand the attraction of becoming “gold backed” overnight.

The absence of Indian demand as expressed by official import figures is negatively impacting sentiment at the moment, but smuggled imports are far from irrelevant. Demand for illegal gold is probably sensed in the physical spot gold market, supporting prices in spite of the sentiment. If import controls were to be lifted, demand would surge, especially with the festival season upon us. Domestic demand at the moment is subdued because rupee prices are relatively high, but with so many conflicting risks to the Indian gold market, volatility is the only safe prediction going forward.

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