Gold mostly to blame for India’s current account deficit

A massive appetite for gold across India is causing the country’s current account deficit to widen as most of the South Asian nation’s gold demand is met through imports, a new study by Macquaire Economics Research says.

“Adjusting India’s US$44 billion (2.6% of GDP as of fiscal 2011) current account deficit with net gold imports, the overall deficit would reduce by almost half to US$21 billion (1.2% of GDP),” Macquarie analyst Tanvee Gupta Jain writes in a Nov. 29 report. “Our estimates suggest that net gold imports alone contributed nearly 40 basis points to the 130 basis points widening of India’s current account deficit between fiscal 2008 and fiscal 2011.”

In volume terms the consumption of gold in India–including jewelry and net retail investment–grew 5% year-on-year during the first three quarters of this year “on top of 72% year-on-year growth registered in 2010” despite a 64% cumulative rise in the price of gold in rupee terms from Jan. 2010 to Sept. 2011.  

Quoting numbers from the World Gold Council, Jain notes that Indians have the biggest gold holdings in the world (11% of global stock), with households in the country owning 18,000 tonnes of the metal.

The analyst estimates that between 7% and 8% of India’s US$329 billion in household savings was held in gold as of fiscal 2010.

As of September 2011, India remains the largest consumer of gold in the world on a trailing four-quarter basis, his report states, and the country’s rising gold consumption is one of the reasons why the rupee has depreciated by 18.6% against the US dollar since August 2011 and why the country has a yawning current account deficit.

“While the weakening trend against the US dollar is across the board,” Jain writes, “the Indian rupee has been the worst-performing currency in the Asia ex-Japan region since August 2011.”

Of merchandise imports, only crude oil and capital goods surpass gold. In gross terms, imports of the metal made up a 9.6% share of total imports as of fiscal 2011. Last year roughly 92% of the gold supply in India was from imports with the remainder coming from recycled gold and other sources. Jain reasons that the purchase of gold is resulting in “imprudent use of foreign exchange earnings.”

Jain also makes the point that because Indian households have always preferred physical savings such as gold, land and houses over financial savings, “the flow of productive savings required to boost investments in the economy has been reduced.”

And a shift to financial assets will be difficult without financial sector reforms and the introduction of long-term savings schemes and products such as gold-price-linked instruments. Until then, he says, the flow of productive savings needed to increase investment in the economy will be extremely low.