'Sink of the world' for 2,000 years, India faces an outright attack on its gold demand...
In CONTRAST to China, the Indian government's attacks on gold investing are well known and increasingly well-practised,
writes Adrian Ash at BullionVault in the second part of this story (read the first here).
New Delhi's latest action is even having an effect, short term at last, amid the collapse in cash transactions following the shock demonetisation of 500 and 1000 Rupee notes last month.
How did the world's second biggest private gold consumer get here? To recap...
That's why Indian citizens were banned from investing and trading in gold amid the balance of payments and currency crisis building after 1947's independence from Britain. Almost
30 years of smuggling followed, with mafia networks and everyday law-breaking growing to match, as people continued buying gold to sidestep the Rupee's continued and steady devaluation.
A fit of commonsense led the government to
repeal that Gold Control Act in 1990, and more deregulation came after the balance-of-payments crisis
which hit a year later, due to a deadly mix of Soviet Russia's collapse (a key export market) and Gulf War I's surging oil prices (India's biggest import, ahead then as now of gold).
So although
exports of bullion were still banned by a raft of complex rules and regulations (bureaucratic habits die hard), India's gold private demand was allowed to waft and wane pretty much as investors and householders chose during the long bull market peaking 2011. The drop in prices through 2012 started to spook India's politicians however, while the Reserve Bank's deputy governor moaned that "90% of India's gold demand is jewelry or to offer to God...
Both have to stop."
Then came the 2013 gold crash.
The authorities had
already hiked India's import duties that January, but it didn't touch the sides as gold sank through $1600...then $1500...then $1400 per ounce. Even with the Rupee falling too, buoying domestic gold prices, consumer demand leapt, sucking in
record-high monthly inflows of gold and costing record-high outflows of cash. That only worsened India's Current Account Deficit with the rest of the world, dragging the Rupee down to new record lows on the currency markets. That only worsened the flight to gold, and so worsened the CAD in turn.
First it tried cash incentives, offering to match the move in gold prices
plus a rate of interest on top through the Gold Monetisation Scheme and Sovereign Gold Bonds. Then it turned on the jewelry trade directly, lowering the value at which any cash transaction or purchase
must be reported to the tax authorities via the customer's PAN card (personal account number) while imposing a new 1% tax at the point of sale. The industry squealed, shutting up shop and
striking for well over a month, all to
no avail but further denting India's imports.
By July 2016's three-year high in the global Dollar gold price following the UK's Brexit vote, the secure airfreight industry was sucking wind yet again as legal inflows to India dried up. One industry estimate
guessed that some 7/10th of all imports were coming via the black market, only confirming the Indian gold business's shady reputation for policy makers – a confirmation their own actions helped bring about.
And then, on the same day as the US election in November, New Delhi went nuclear on India's black-market economy and untaxed wealth. With just 4 hours' notice, Modi announced that India's highest denomination banknotes – worth some $7 and $15 each in an economy generating $5 per head per day in 2015 –
would cease to be legal tender. This demonetisation killed 86% of currency in circulation, forcing pretty much everyone to cue at their bank to deposit the now useless paper, for full value, into their accounts before the end-December deadline.
Why so drastic? Hardly anyone pays income tax in India – as
few as 1% on official data – and untaxed transactions might account for half of economic activity on some estimates. Corruption is endemic, and the Modi government – in line with Western authorities – thinks physical cash does more than simply enable it. So despite all this chaos, Modi's move
is still mostly backed by the population, at least according to Indian media. Because corruption is a terrible drag on doing business and everyday life in general for the vast majority of voters.
Untracked and untraceable, banknotes are the lifeblood of backhanders and bungs. But New Delhi sees physical gold as the fat store, holding value – again untracked and untraceable – far from the Revenue Service's grasp until the ordinary householder's everyday criminal acts need to release it as cash. (Another such store is real estate,
now next on Modi's list of tax evasion targets.) One senior bullion-market bank executive
reckons that 10-30% of India's gold investing and jewelry demand is paid for using so-called 'black' money. That guess might jump higher still for any metal sold since demonetisation struck – again confirming the industry as crooked amid the impact of the government's own policies.
Jewelers can't even buy people's gold back from them legally, because there's no cash to pay them with and no hope of re-selling again because there's no cash for local buyers to pay with and bullion exports are banned. Many individual jewelers and dealers are meantime being pursued by the tax authorities for accepting the now banned banknotes after the 9 November deadline, with the giant Axis Bank
freezing at least 50 gold business's accounts for suspicious deposits. And while
last month's surge in (legal) gold imports fits the usual model for how India responds to a price drop, the media and Modi government are taking it as proof positive that the gold industry sold metal for illegal cash, helping people launder savings they would otherwise have had to declare to the tax man by putting it into the bank.
All told then, the cash crunch and uncertainty show no sign of ending just yet, precisely while the global gold price looks for a floor amid the post-Trump sell-off by Western ETF shareholders and other professional investors. Alongside Beijing's
restriction on gold imports to China, "We do not expect either situation to ease meaningfully before the next Indian budget and Chinese New Year," says precious metals strategist Tom Kendall at global bullion bank ICBC Standard, "both of which will fall around the end of January 2017."
Key to resolving the collapse in India's import demand will be the decision on GST – the General Sales Tax, currently under (heated) discussion by a government-appointed committee, and aimed at simplifying and unifying revenue raising across the world's second most populous nation from 1 April. It should be detailed in the Government's 1 February budget, and some people
seem to think the net tax-take on gold purchases might go down. Maybe they have somehow missed the plain intent to reduce gold demand shown by Modi's BJP administration.
Will that succeed long term? Banning imports failed between the 1960s and 1990's repeal, and hiking duty and tax rates only boosted black market inflows again over the last 5 years. Yes, the shock and awe of Modi's demonetisation bombshell is certainly worsening the 2016 plunge in demand – a fact which Western investors and traders hoping Indian buyers will stem any further price drop cannot ignore. But 2016's drop in Indian gold demand began alongside the first-half's strong price gains. November's surging imports show the underlying model working when prices turned lower as well. And India's deep love for gold has overcome everything government has thrown at it to date.
As for China, Beijing has by all accounts tapped the brakes in gold inflows by restricting the number of licenses it issues. But inflows to where? The international free-trade zone in Shanghai doesn't count as China, not for import purposes, not until bullion crosses the line into the Shanghai Gold Exchange's domestic section. All that gold leaving Western ETF accounts in London and also Comex warehouses in the US must be going somewhere.
Word is, Switzerland is seeing heavy shipments of .9999 fine gold, the high-grade kilobars loved by the Far Eastern markets. Just maybe the two are connected.
