In a surprise move, the Trade Ministry in India has introduced a proposal which would see the import duty on gold being reduced by 80% from 10% to just 2% . This is the same tax rate which was used until a few years ago when the Indian government decided to gradually increase the import tax to fill the government’s treasury again. This resulted in the total import of gold to drop by approximately 50%, so the big question will be whether or not the reduced tariff will incentivize the purchase of more gold again.

The trade ministry thinks the reduction of the import tariff will boost the jewelry sector in the country as the jewellers would be incentivized to purchase more gold for finer end-products. The goal seems to be to make India one of the world’s centers for gold jewelry. Another advantage would be the fact the government would spend less efforts fighting the illegal smuggling of gold and this manpower could be deployed in sectors/situations with a higher priority.

Source

Obviously the main question we would ask ourselves is ‘Will this have an effective impact on the gold imports in India? And if so, can we quantify the impact?’. According to research from the French commodity-focused company Natixis, India imported just over 500 tonnes of gold in 2014 which was a sharp decline compared to the 716 tonnes in 2013. This reduction was mainly caused by the ever-increasing import duties as well as the weak Indian Rupee (which was actually good for the company main export sectors). As you can see on the next chart, the value of the Indian Rupee decreased quite fast.

 USD/INR exchange rate. Source

Even though there surely will be an uptick in the ‘official’ gold demand, it’s too early to estimate the true impact of this lower import tariff. However, the official import numbers will very likely show a stellar performance in 2015 should the proposal become law. As of this moment roughly 200 tonnes of gold were illegally imported into India last year, of which a large part is coming in through neighboring country Bangladesh where smuggling stories are being published quite often.

The reduced tariff will incentivize buyers to prefer the ‘legal’ import route as a 2% tax is negligible and not enough to warrant taking the risk of smuggling gold into the country. So whilst the legal import numbers will show a nice increase in the amount of imported gold, it’s too early to be optimistic as we expect it will simply reflect a shift from the illegal gold import numbers to the legal import numbers whilst the total effective demand will remain stable. However, there will be a spillover effect on the retail demand in India as people will now be able to buy 8% more gold for the same investment. So even though we aren’t expecting huge shifts on the jewelry-level, the demand from retail buyers will very likely increase. Not in a 1 on 1 ratio, but more like a 2:1 ratio and the retail demand could pick up by as much as 5%.