The Lure Of Gold The Deficit Is Widening

Posted in Finance Articles, Total Reads: 2787 , Published on 16 December 2013

The Indian gems and jewellery sector has grown rapidly over the past few years. The sector has won worldwide acclaim due to the availability of skilled craftsmen, superior techniques for polishing & cutting and cost efficiency. Players source, manufacture, process and sell gold, silver, platinum and precious gemstones. In India, gold jewellery is most preferred as it is considered auspicious to purchase gold on occasions like festivals, marriage, birth etc. Gold is also perceived as a relatively safer investment option.

Gold and gemstones, the raw materials used by the industry, are mainly imported. Rising domestic demand for gold has been driving up imports over the past couple of years. A sharp rise in gold imports in recent months (and its impact on the current account deficit) has prompted the government and the Reserve Bank of India (RBI) to announce the following measures in 2013:

Image Courtesy: Boykung,

Union Budget 2013-14 proposals

• Import duty on precious and semi-precious stones reduced to 2 per cent from 10 per cent.

• Duty-free concession on jewellery carried as hand baggage by air travellers, has been increased to Rs 50,000 for male passengers and Rs 1 lakh for female passengers.

• A commodity transaction tax of Rs 10 per lakh was introduced in the budget on trade in non-agri commodities such as gold, silver, non-ferrous metals and crude oil. Until now, commodity transactions were exempted from any levy.

• A 4 per cent excise duty was levied on silver obtained from copper ore and Zinc.

• The budget also allocated Rs 10 billion to enhance skill sets of youth who could be employed in the sector.

First of all we need to understand what the growth drivers for industry are:

Growth drivers - Domestic

• Rising incomes: As jewellery is considered as a lifestyle product, demand is largely driven by a rise in disposable incomes.

• Favourable demographics: More than half of India’s population belonged to the age group of 20-59 years, as of 2012. Bulk of gold demand comes from this category.

• Rise in number of working women: Women have traditionally been major demand drivers for gold and jewellery. Special designs launched to address the needs of working women, such as light weight daily wear jewellery, have been driving growth among women.

• Traditional demand and changing preferences: India is the largest consumer of gold in the world, Jewellery (worn at various occasions) constitutes about two-thirds of total gold demand in India. While the penchant for gold will remain unchanged in the long run, there is also a rise in awareness among consumers about diamonds, pearls and other types of jewellery. To tap into this demand, various retailers are offering a wide variety of products (lightweight jewels, platinum jewels, etc) that are exotic as well as affordable.

• Savings and investment vehicle: Gold and gold jewellery also form an important investment avenue in India as it is perceived to provide a hedge against inflation.

Increase in import duty on gold

The government, in a bid to cut the imports of gold, has increased the import duty on gold bar imports from 4 per cent to 6 per cent with effect from January 21, 2013. The duty on gold alloy has also been increased from 2 per cent to 5 per cent. The increasing current account deficit, which stood at 4.2 per cent of the GDP in 2011-12, has mainly pushed the government to take such a decision.

Along with the increase in import duty, the government has also proposed to partially free the physical gold held under Exchange-traded fund (ETFs) by allowing mutual funds to deposit some of their gold holdings with banks under the gold deposit scheme. This will bring into circulation a part of gold that is lying in stock domestically, partially meeting the requirements of the jewellery manufacturers. Along with this, the reduction in minimum quantity of gold that may be deposited by individuals in banks and the reduction in minimum tenure of such deposits from 3 years to 6 months is also proposed.

The increase in import duty on gold to have a limited impact on domestic gold demand as prices increases are expected to be absorbed by customers. Though, imports are expected to decline, higher domestic supply from exchange traded funds will offset import decline. Jewellery exporters especially for low value added products are expected to see pressure on margins.

Domestic market

The increase in import duty by 2 percentage points will increase the price of gold based jewellery as the players are expected to pass on the increase to customers. This will put a marginal downward pressure on volumes in the short-term as the buyers will take time to adjust to new prices.

The assets under gold based ETFs are around Rs 119.9 billion as of December, 2012 while India's imports of gold bars are estimated to be Rs 597.8 billion in 2012. Before the current regulations ETF's were required to stock gold as pledged asset of at least 90 per cent of the value of their portfolio. If 10 per cent of the value of these holdings comes into circulation, it will increase the supply of gold by around 1 per cent in the market which is expected to partly offset increase in gold price on account of higher import duty. Also, the relaxation in the norms of gold deposit scheme will also bring some gold into circulation which will further increase the supply of gold.

It believes that the increase in import duty on gold to have a limited impact on domestic gold demand as prices increases are expected to be absorbed by customers. Though, imports are expected to decline, higher domestic supply from exchange traded funds will offset import decline.

Fall in gold prices to impact operating margins of gold jewellery players

Gold prices have declined by close to 12 per cent over last week to Rs. 25,650 per 10 gm on April 16, 2013. The decline has been much sharper from the recent highs of Rs. 32,500 per 10 gm nearly eight months ago. This fall during the past one week is expected to cause significant inventory losses and impact margins of gold jewellery retailers and exporters in Q1 2013-14.

The inventory holding period for a domestic gold retailer is close to 120 days; while, for exporters, it is close to 90 days. As inventory holding days are higher for domestic retailers compared to exporters, domestic gold retailers are expected to see a sharper contraction of 150-200 bps in their operating margins, as compared to gold jewellery exporters, who could see margins decline by 100-150 bps in Q1 2013-14. Exporters tend to have lower net margins in the 1-2 per cent range, given the high interest costs; hence, the impact on their net profits would be more severe compared to domestic retailers. The impact of the price decline could vary across players, depending on their level of hedging. We have assumed that half of the gold purchases have been hedged, for our calculations.

Gold prices to decline after 12-year Bull Run; dampen market sentiments

Although international gold prices remained flat in 2012-13, domestic gold prices increased by 17 per cent y-o-y, due to a depreciation in the rupee and a hike in the import duty. In 2013-14, we expect international gold prices to average about 16 per cent y-o-y, as the yellow metal becomes less attractive for investments. However, the decline in domestic gold prices will not be as steep and will be limited to 8-10 per cent in 2013-14. A further hike in the import duty on gold (in June 2013) and a weak rupee will cushion the decline in domestic gold prices.

Overall demand growth to remain sluggish

Soaring gold prices drove up the industry revenues by 13 per cent y-o-y in 2012-13. In 2013-14, CRISIL Research estimates revenues to grow at a muted 1-3 per cent due to the decline in gold prices. In 2013-14, we expect domestic demand to grow at a sluggish 0-2 per cent. However, lower gold prices will spur a strong rise in jewellery sales. Demand for gold bars and coins will decline as the metal becomes unattractive as an investment option. Ironically, in 2012-13, high prices had stunted sales in this segment. Despite a lacklustre forecast, the domestic market is expected to retain a dominant share in overall revenues.

Growth in overall exports is also expected to be muted at 0-2 per cent (in dollar terms) y-o-y. However, among segments, there will be a complete reversal vis-à-vis 2012-13. Last year, overall exports fell, led by a sharp decline in demand for cut and polished diamonds. On the other hand, gold jewellery exports grew by 33 per cent. In 2013-14, exports of diamonds are expected to grow by 20 per cent led by an improvement in world demand. But, exports of gold jewellery will decline, due to lower gold prices.

This article has been authored by Ronak Johari from Indian Institute Of Management Ranchi




• Union Budget 2013-2014


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