The love for gold is ingrained in the ethos of a typical Indian household and this has kept gold imports robust throughout the ages. There is a dichotomy: On the one hand, gold is deeply rooted in the socio-economic fabric of India. But from an economic perspective, gold continues to weigh heavily on India’s import bill as a significant contributor to its current account deficit. However, amid this constant tug of war, the government’s demonetization drive is going to impact gold imports especially in the short to medium term.

Economics of Gold

India has a flourishing gold industry – it employs around 2.5 million people and contributes more than $30 billion to the domestic economy. India’s fast-growing gem and jewelry exports market is led primarily by gold. In fiscal 2013, gems and jewelry constituted 15% of India’s total exports and the value of gold items alone was more than $18 billion, as per a report by World Gold Council and FICCI.

However, India’s demand for gold isn’t satisfied by its little domestic supply. During 2014, India’s demand for gold was recorded at 987 tonnes, while its domestic supply was a mere 102.8 tonnes. As per WGC, “Over the past five years, the annual demand has averaged to 895 tonnes, equivalent to 26% of total physical demand worldwide. For many years, the most avid purchaser of gold in the world, India remains one of the leading markets for gold globally today.” India’s gold import bill in 2014 was $31.17 billion, while the same increased to $34.98 billion during 2015. (Related reading, see: Bitcoin Prices in India Soar Amid Demonetization Drive)

Demonetization & Taxation

The unanticipated decision of demonetization by Prime Minister Narenda Modi's government has created ripples in the industry. Soon after the announcement, people rushed to buy gold, which soon stabilized as the government emphasized on the need furnish PAN (Indian Permanent Account Number) card details for accountability purposes. Many jewelry shops that were flouting the norms came under crackdowns. Simultaneously, rumors of a gold ban started to float, which led to agencies ramping up volume of gold import. Overall, the rush to park idle cash lying with people and the rumors of a ban led to a jump in the import of gold to around 100 tonnes during November, the highest since 2015, as reported by Reuters. However, the same volume hasn't been absorbed and a significant amount of the import remained unsold which is likely to result in lower levels of gold import during December amid weak demand.

The current scenario is contrary to how demand for gold behaves during this time of the year in India. A report by CARE points out, “In H2CY2016 [second half of calendar year], demand was earlier expected to be better due to festival season, wedding season, good monsoons and 7th pay commission implementation. However, demonetization might impact consumer spending on luxury items, and domestic demand for gems and jewellery is expected to be muted in the near to medium term.” Going forward, the demand is expected to revive fully during H12017 which will push up imports as well.

The move of demonetization created fear regarding the ways gold will be taxed by the government. Finance Minister Arun Jaitley tweeted a snapshot of the income tax law in respect of gold jewellery to bring more clarity.

Points clarified by ministry to remove any doubt about the current position of Income Tax Law in respect of gold jewellery

— Arun Jaitley (@arunjaitley) December 1, 2016

The Bottom Line

The initial few days did see the shutters of jewellery stores closed, as there were practically no sales due to the lack of new currency in the market and the strict implementation by the regulators. However, in a country where the appetite for gold is insatiable, demonetization may have slowed down the gold demand for a couple of months. The demand will be back on track and so will the gold imports. (Related reading, see: Understanding the Trends Driving India's Rise)