The Indian Economy and Gold Imports

by: Shailendra Kumar

After my last two articles regarding the impending fall in Indian gold consumption, there has been a flurry of emails. Frankly I am surprised by the response. I did not know so many people out there would be interested in Indian gold consumption. Now I stand corrected.

Since it is difficult to give response to so many individuals, I would try to address them openly. It is easy to do so since most of the emails are loaded with common questions like "Wouldn't the agriculture economy pick up soon?", "Why does Indian economy look suddenly so bad?", and "Wouldn't the Indian stock market rise soon to its former glory?"

Many readers have shown concern that the fall in Indian buying will downgrade the outlook for gold prices. Many think that the reduction in Indian buying will result in gold hitting back $600 levels. Some have even wondered what would be the future of gold ETFs in light of the waning gold imports. Let us look at some of these apprehensions one by one.

1. "Wouldn't the Indian agriculture economy pick up soon?"

Most questions are about the state of rural Indian economy. "Wouldn't the agriculture economy pick up soon?" "Wouldn't the farmers be able to benefit from the rising agri-commodity prices and be able to buy more gold?", "Wouldn't the boom in wheat, soyabean, and corn push the farmers to visit the jewellery shops often?"

The answer unfortunately to all these questions is a clear NO. The condition of the Indian agriculture is so bad that even a boom in the commodity prices is not able to help the farmers. Even if the prices are up, the grinding poverty forces most farmers to sell their crop too soon, too cheap, thus barely allowing them to reap the real benefits of the boom. More, even if they realise somewhat higher prices, they also end up spending lot of extra money on costlier farm inputs, thus keeping their profit levels more or less at the same level.

The condition of the farmers will only improve when the agriculture industry gets serious attention from the federal and state governments. This is not happening. In spite of 70% Indian population dependent on farming, the sector gets least attention from government of any hue. Due to this the farmers don't have access to best seeds, proper fertilisers and insecticides. Farmers travel for hundreds of miles to get good quality seeds. Farm inputs are often in shortage; current agriculture season has even seen farmers' agitations in many places because of shortage of fertilisers. How the farmers will prosper if their time goes arranging seeds, fertilisers and irrigation water. It is this state of farming which has compelled thousands of farmers to commit suicide. Goes without saying, farmers are unlikely to be thinking about gold and gold jewellery.

2. "Why does the Indian economy look suddenly so bad so suddenly?"

The fact is Indian economy was always in bad shape. It never was what was being projected in mainstream media: "the shining India", "the knowledge superpower", "the toast of the emerging markets" and so on. India was a sick economy and it continues to be one. The sickness was hidden primarily because of the rise in stock markets, which were driven less by fundamentals and more by excess liquidity in global financial bazaars. When Mr. Greenspan slashed the interest rates after the tech bubble burst to unsustainably low levels, he not only created a housing bubble, he also created a bubble in emerging economies around the world. A whole lot of money travelled out of the US towards the new markets. India was a big beneficiary of that flow, simply because of the misguided notion that India is another China, which it is not. So the current weakness in Indian economy is not something new; it is something latent.

In fact the weakness has been growing by leaps and bounds during past two years. The rise of crude oil price has eaten the Indian economy hollow and has in fact pushed the country back many notches on its financial path. During past two years the cost of crude imports has gone up from $40 billion to approx. $100 billion - an unaffordable luxury for a poor nation like India. This escalation in the energy bill itself amounts to about 6.5% of the country’s GDP. (This percentage is set to rise, given the fact that the GDP is declining and the crude consumption is rising.) The situation is laughable; a country whose total exports amounted to $155 billion last year is likely to spend over $100-120 billion on the import of one single commodity. If this parameter was to be the sole criteria of judgment, India will emerge as the number one importer of crude oil in the world, and would give more teeth to those who blame India and China for the rise in the price of crude.

Worse, the country is not passing on this rise in the crude oil to the consumers; they are being shielded because of vote bank politics. (While the Indian crude basket has risen by 181 percent since April 2004, the retail prices of petrol have gone up just 29 percent until the end of year 2007.) In other words, the government treasury goes on taking it on its chin while the consumers are blessedly unaware about the rising prices. As a result while on one hand the consumption continues to grow unabated, on the other the country's finances continue to take a hit below the belt. The balance sheet in fact is already in the red due to the losses this country has taken on account of fuel subsidies, and even if the crude price was to fall to a mere $100/barrel with immediate effect, Indian economy would not be able to recover from the wounds it has already received.

Of course, the danger is not just limited to the escalating crude oil price. The growing fertiliser subsidies are burning another hole in the pocket. The government imports urea at Rs 31,116/ton and sells it for Rs 4,830/ton. DAP is imported at Rs 58,584 and sold for Rs 9,350/t. MOP is imported at Rs 35,563/ton and sold for Rs 4,455. The amount of subsidy given by the government has been climbing steadily over the years and today stands at a whopping Rs. 119,772 crores (estimated for 2008-09) - almost three times higher than the amount doled out during the previous year.

The surging oil, fertiliser, and food subsidies are likely to upset the entire applecart of Indian finances. The annual DGGP growth at constant prices is already in serious decline. Very strong revenue gains, which masked many shortcomings of the economy in yesteryears, are also showing signs of slowdown. And as if all this was not enough, India's trade deficit is likely to exceed 8% in FY09. According to Moody's latest report on Indian economy "higher oil prices and lack of fiscal policy reactions amidst high pent-up price pressures are putting the burden of macro-economic adjustment on monetary authorities. As a result, policy as well as market interest rates could rise, and a sharp deceleration in growth may follow."

India. A few weeks back international rating agency Fitch Ratings downgraded India’s local currency outlook from ‘stable’ to ‘negative’, mainly on account of the deteriorating fiscal position of the Union Government. Fitch assigned India’s long-term foreign currency IDR at `BBB minus’, its short-term foreign currency IDR at ‘F3’ and the country ceiling at ‘BBB minus’. The agency said that India’s long term currency issuer default rating (IDR) outlook was being revised to negative from stable while affirming the rating at ‘BBB minus’, in light of the fact that the trade deficit was likely to widen to 8.2% of GDP in FY09. The rating agency attributed the negative outlook to an increase in government debt issuance to finance subsidies not captured in the budget. Higher budget subsidies, interest payments, public wages and bonds issued to oil and fertiliser companies could increase the fiscal deficit to 6.5 per cent of GDP in 2008-09, predicts Fitch. Fitch's ratings were seconded by the forecasts of Standard and Poor (S&P) which lowered their India growth forecast for the current year to 7.8% from 8.1-8.6% earlier. S&P also maintained that the Indian economy would be hit by the surge in inflation fuelled by energy and commodity prices.

3. "Wouldn't the Indian stock market rise soon to its former glory?"

How can the stock market revive when the very fundamentals of the economy are shaking threateningly? How can the markets stay up when the rating agencies are painting such a gloomy picture? Finally, how can the markets go up when the government is out to curb growth and is focussing all its energy on controlling inflation, already within a whisker of 12%? If inflation remains quite high - as it is likely to be - the cost of capital will go up dramatically. Already the Reserve Bank of India has begun to increase the repo rate and the CRR, and the result is the increase in borrowing costs not only for individuals but also the corporates. The ‘anti-inflation’ credit policy Reserve Bank of India means higher borrowing costs for Indian companies, thus denting their profitability further. (The RBI in its recently declared credit policy raised the key lending rate by 50 basis points to a seven-year high of 9 per cent as well as increased the cash reserve ratio by 25 basis points to 9 per cent.) Consequently, several large companies are already putting capacity-expansion plans on hold. Staff hiring is slowing. Investment in technology upgradation is losing steam. The real sufferers are the small and medium sized companies, who don't have much money in their pocket and don't have strong credibility in the market to borrow at decent rates.

The rise in the lending rates is also hurting the retail customers. Retail lending rates across most products - auto loans, personal loans, and loans against securities - have been going up in recent past and are likely to do so in the coming future. The customers are unable to borrow, thus capping the demand as well as pushing up the loan defaults. (Bad loans have been rising across most retail products in the past few months.) Goes without saying the companies in India are taking a double hit: rising cost of capital and inputs and lowering demand due to reduced purchasing power by the customers. The two phenomena have already reduced the rosy projections by company analysts about stock price forecasts way behind the curve.

Not surprising why a recent survey of corporates by RBI showed gloomy results. The latest industrial outlook survey - a survey of corporates and businesses on the quarter ahead expectations - indicated that many companies were uncertain about whether the overall business situation would improve during the next quarter. The change in outlook had a lot to do with a worsening macro-economic environment, marked by high oil prices, inflation and rising interest rates.

Not a surprise either why the Indian stocks have been falling like nine pins. The risk appetite of most sworn bulls has reduced considerably. They have significantly slowed down their new investments. No new money is entering the markets and even the old one is desperate to get out. Dozens of mutual funds are sitting on huge piles of cash, frightened to invest it in the stocks, and trying to smile while earning 8-10% in debt instruments. There are funds which have raised hundreds of millions of dollars and yet are unable to invest, simply because they have neither the courage nor the conviction to call the current level as "the bottom." FIIs, the underwriters of the boom just gone bust, are also unwilling to scale up their purchases. They have sold about $6.5 billion worth of shares YTD, and are just unwilling to buy even those stocks which are 70-80 percent off their peak.

No doubt, the bottom is yet to show up. The FIIs are just not selling because they know the market will tank. They know that there is no other entity which can absorb their sales. (That a mere $6.5 billion sale has sunk the stock indices by about 40 percent shows the depth of the market and the strength of the economy.) Meanwhile the next round of selling pressure may well come from domestic mutual funds, as the sustained erosion in net asset values will prompt many of them to redeem their holdings. Additional pressure on market indices will come when the retail investors are given a clear "don't buy" signal by the brokerage houses. So far the brokerage analysts continue to issue downgrades in terms of price targets, however it is a matter of time before they in stead of merely reducing the price-earning multiple of the stock, begin to actually start downgrading the earnings potential of the most popular companies. They are forced to do so; the expenditure of most corporates is flying sky high, given the escalated energy costs and the wage hikes as well as the double digit inflation, and it is a matter of time before their bottom-line end up in red ink.

So the simplest answer to the question "Wouldn't the Indian stock market rise soon to its former glory?" is: NO. The Indian market is not likely to revive, at least not during next couple of years, possibly more. Leave alone the Sensex reaching the former heights, it is a matter of time before it sheds its ill-gotten blubber and ends up in four digit levels. It is my estimate that Sensex which was at about 21,000 at the beginning of the year - and is currently quoting at about 14000 - should settle down to 8000 within 6-9 months from now. What's worse, I don't foresee any chance of revival even from those lowly levels. Sensex will continue to remain in four digit levels till the Indian economy recovers from the single biggest shock it has taken during past sixty years: the rise of crude price. Since the recovery will be extremely slow and painful, I fully expect Sensex to languish at 7-8000 for a period sufficiently long to make people averse even to talk about the stocks and mutual funds.

In fact buying gold at current prices is the only course left for Indian investors to salvage their stock market losses. However they are unlikely to act it out. The ceaseless pushing of stocks and paper assets during past two decades have clouded most Indian investors' psyche to a level where they don't even consider gold as an instrument of investment. They think of it as a soft metal good enough only for hammering out a nose ring or a bracelet. This is the reason why the gold ETFs have failed in India, even as they are a roaring success in the industrialized world.

The sum and substance: the Indian demand for the noble metal is unlikely to pick up from now on. Given the condition of the Indian economy, I would not be surprised that Indian imports soon - and it can be pretty soon - fall to about 500 tonnes from the current about 700-800 tonnes per year. This may worry some gold mining industry captains and some sworn gold bugs, but honestly they should not be gloomy. There are many other factors out there to propel GOLD: God's Own Currency.