The Indian government’s surprise decision to abolish high-value bank notes this week has triggered a massive – if temporary – surge in domestic gold prices.
But there are downside risks for gold demand once this phenomenon ends, market participants said.
Domestic gold process rose this week while consumers sought to dispose of bank notes that are soon to be unredeemable, market sources said.
Earlier this week, Indian Prime Minister Narendra Modi announced the withdrawal from circulation of 500-rupee and 1,000-rupees notes – the highest value and most widely used banknotes in the country – in a crackdown on the black market and on forgeries.
Some 28% of those notes in circulation are fakes, the World Bank estimates.
Notes of those denominations in circulation are no longer legal tender but will be accepted by banks and post offices to December 30.
“The immediate effect may be a very short-term splurge of spending on gold jewellery and other high-value articles as individuals seek to offload the soon to be obsolete notes,” ICBC Standard Bank analyst Tom Kendall noted.
“However, how the government and RBI decide to balance the level of GST (goods and services tax) to be imposed on gold and jewellery with the import duty on gold bullion will potentially have a much greater impact. An announcement on that is likely before year end, and certainly before the 2017-18 budget, expected in late January,” he added.
Also, this scheme creates risks for discretionary consumption, UBS analyst Joni Teves said. According to the Boston Consulting Group, cash accounted for around 78% of overall consumer payments in India last year.
“The government’s aim to ultimately discourage cash transactions could hold downside risks for gold demand, especially during this transition period. That this simultaneously encourages bank deposits could also have longer-term negative implications on gold in as much as bank accounts could eventually diminish or even replace gold’s role as a means of accessing financing, particularly in rural areas,” Teves said.
The World Gold Council cut its forecast for Indian demand to 650-750 tonnes in 2016, which would be the lowest level since 2009.
“The concern for the gold market is that all-important Q4 demand may now decline,” Metals Focus noted.
Although the government has drawn up plans to issue new 500-rupee and 2,000-rupee notes with security measures, ensuring that cash-based transactions will continue, it is not yet clear what the impact on gold will be over the longer term, it added.
“Even allowing for the benefits to the formal sector, the damage to the parallel economy could see Indian gold demand eventually weaken,” Metals Focus warned.
According to the preliminary data from the Indian Ministry of Finance, Indian gold imports in October more than doubled, both month-on-month and year-on-year, to 96.7 tonnes, Commerzbank noted.
This reflected high demand during the festival season. Dhanteras and Diwali – two of the most important festivals in the Hindu calendar – were held at the end of last month when gold is traditionally given as gifts.
(Editing by Mark Shaw)