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More Drastic Steps Needed to Curb India Gold Bugs

Thursday, 6 Jun 2013 | 4:46 AM ET
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India, the world's largest consumer of gold, has stepped up its battle against gold bugs by raising an import duty on the yellow metal to 8 percent from 6 percent late Wednesday – its fourth such move in 18 months.

But market watchers are doubtful the measure will do much to curb demand, especially with gold prices at such attractive levels.

"If 6 percent did not stem the tide of purchases then I really do not see what 8 percent will do. Buying gold is a cultural experience. Indians will always do it. If they see value they will buy it, which they have and will continue to," Jonathan Barratt, chief executive at Barratt's Bulletin, a commodity research firm.

Tom Price, global commodities analyst at UBS, added that once the new tax is imposed, consumers will likely adjust around it relatively quickly.

(Read More: How Gold's Fall Will Affect World's Biggest Consumer)

Over the past year and a half, the South Asian nation has been actively targeting gold imports – its biggest import after crude oil – in order to reduce its current account deficit which stood at 6.7 percent of gross domestic product in the December quarter. The government first increased the import duty on gold back in January 2012, hiking it to 2 percent from a flat rate of 300 rupees per 10 grams. The latest move means taxes have quadrupled since.

Earlier this week, the government sought to deter demand for bullion by issuing inflation-indexed bonds as an alternative to gold for domestic investors.

Gold is widely regarded as a store of wealth among Indians and is seen as an inflation hedge, so moderating demand has proved a difficult task, particularly with gold prices falling to a two-year low in April. Gold imports in fact surged 138 percent year on year to $7.5 billion in April as consumer took advantage of lower prices.

In order to be impactful, commodity analysts believe the import duty would need to be raised into the double digits.

"Really, the only way is a substantial lift in trade taxes. Move into double digit numbers. If you're in single digit tax numbers, 10 percent or above would shock the market and you would see an impact," said Price of UBS.

Can Indian Inflation-Bonds Curb Gold Buys?
This isn't the first time the India government has tried to control gold buying. Anita Yadav, Managing Partner at SJ Seymour Group tells Cash Flow what makes things different this time.

Ric Spooner, chief market analyst at CMC Markets agreed a double-digit taxation rate may be more effective, adding that the government will likely monitor import data over the coming months before making such a decision.

"There are political costs to doing more - otherwise the government may have done more from the outset. They will take an incremental, wait and see approach," Spooner said.

According to Taimur Baig, chief economist for India at Deutsche Bank, no further steps may be necessary, noting that demand for the precious may decline as inflation tapers off. India's wholesale price index (WPI), the main gauge of inflation, rose just 4.89 percent in April - moving into the central bank's comfort zone of around 5 percent for the first time in over three years.

"Why have Indians been buying so much gold? They have been using it as inflation hedge, and because there are so few investment opportunities with the economy doing poorly," Baig said.

(Read More: India Benchmark Wholesale Inflation Slows in April)

"I see both of those factors being ameliorated going forward. The government is trying to revive the investment environment and inflation is coming down. Gold demand should fall this year anyways," he added.

By CNBC's Ansuya Harjani

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