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By Anthony Harrington

The coming together of a number of factors has prompted India's Finance Minister P. Chidambaram to appeal to his fellow countrymen and women to give gold a rest. Indians annually buy up billions of dollars worth of gold, causing substantial outflows of rupees into U.S. dollars and adding significantly to India's negative balance of payments. Gold, after all, is the country's second biggest import after oil. But unlike oil, gold purchases suck money out of the economy without creating any discernible positive impact, other than giving individual citizens (often at the bottom of the earnings pyramid) a comfortable feeling that they are building a hedge against hard times. Oil, by way of contrast, at least has the merit of powering industry.

What Chidambaram realizes is that India's status as the world's biggest importer of gold is adding massively to India's current account deficit, which Jason Overdorf, in an article in CNBC's The Global Post puts at 5.4% of GDP. The fact that the price of gold broke below $1,200 briefly recently (at the time of writing it was nudging $1,300 again) has so far had only a minor dampening impact on Indian gold purchases. Most Indian "gold bugs" seem to be viewing the dip in the price of gold globally as a wonderful buying opportunity, much to the chagrin of India's economists and bankers. If the gold bugs are pausing at all in their pursuit of the yellow metal, it is mainly because they anticipate being able to buy it even more cheaply a little way down the line.

At a time when the rupee has plunged to historic lows against the U.S. dollar, this is not good news. The rupee's fall, of course, has to do with a great deal more than excessive/obsessive gold purchases by individual Indian citizens. Asian currencies generally fell in mid July after U.S. Federal Reserve Chairman Ben Bernanke confirmed that the Fed would start tapering back on its QE program by the autumn if U.S. economic signs stayed positive. Less-to-no QE spells an end to the weakening of the dollar, at least in the minds of currency traders, and Asian currencies, which had been rising against a weakened dollar, felt the crunch. This has not been good news for mid-sized Indian businesses, many of which borrowed offshore in dollars and enjoyed making payments in rupees.

A plunging rupee amplifies their borrowing costs and with many trading on wafer thin profit margins, that is not good news. Some companies with loans running back to 2007 are now probably facing interest payments that are up some 30% by comparison with the opening months of their loans. By July 18, 2013, the rupee had lost 10% of its value against the dollar since the start of May, and over 50% of its value by comparison with April 2008 (which was, admittedly, a 20- to 30-year high point). As Reuters points out in a recent article, this means that Indian companies have to generate a lot more rupees simply to meet their interest obligations, never mind paying down the principal, which now looks significantly larger than when they took out their overseas loans.

India's economy is currently growing at its slowest pace for 10 years, with Bank of America cutting its GDP forecast for India to 5.5% from 5.8% Reuters says. The total dollar debt holdings of Indian companies amount to some $200 billion, as of March 2013. The problem for Chidambaram on the topic of gold and India's worsening balance of payments is that the uncertainty that inevitably follows an economic slowdown will make the average Indian consumer more likely, rather than less likely, to buy and hoard gold. Exhortations by politicians tend to fall on deaf ears under such circumstances.

Source: Why India's Love Of Gold Has Its Downside