The Pure Gold Company

What effect has India’s recent cash withdrawal and its new efforts to tax physical gold held by individuals had on the international gold price? The Pure Gold Company explains.


By Joshua Saul

For decades, India has struggled with the problem of ‘black money’, usually rupee notes that were either illegally obtained or not declared for tax purposes.


While much of this money has been held in cash, the massive scale of India’s illegal economy (some estimates put it at around a fifth of the country’s GDP, others estimate higher still) means that much of India’s black money is held in two asset classes: property and gold. Until the recent clampdown, gross gold imports in India were at 2.3% of GDP, and many private citizens opted to store their money in gold in preference to bank deposits of cash, the rates on which barely beat inflation.


The prevalence of black money presented a major headache for the government. With only 2.5% of Indians paying income tax, revenue was 33% of what it should be. Other problems include corruption and the difficulty of tracking informal cash-based labour (around 85% of the economy) as well as large scale scams involving powerful politicians, endemic electoral fraud and offshore money transfers. According to a recent study, 21 million US dollars worth of black money exited india in 2014, much of it in gold import and export. This followed a revision of previous data to include Swiss figures covering gold exports.


“Due to India’s large imports of gold from Switzerland, rectifying this data issue significantly closed observed bilateral trade gaps between the two countries,” economist Joseph Spanjers, one of the report’s authors, told the Times of India. He went on to thank India’s Directorate of Revenue Intelligence and the Swiss Directorate General of Customs for cooperating in the process.


Drastic measures

In an attempt to clamp down on the black money problem, India’s new Prime Minister Narendra Modi declared a sudden and rapid withdrawal of all 1,000 and 500 rupee notes on November 8th of 2016. The withdrawal essentially invalidated 86% of all cash in circulation, causing numerous problems with cash undersupply. Insufficient numbers of the new 250 and 2,000 rupee notes had been printed, resulting in businesses grinding to a halt and 0.5% disappearing from India’s predicted GDP growth overnight. In addition, citizens bringing in cash to exchange were subjected  to checks and balances to determine if they’d acquired their money legally, making it difficult to bring in undeclared cash in old banknotes for exchange to new.


There were other consequences for the Indian gold market. It might be expected that a sudden withdrawal of cash might lead to a surge in gold demand, as investors seek to position their black money assets in legal physical gold in order to ‘launder’ them and preserve them from the rupee recall. To an extent this did happen, gold prices in India surging from RS35,000 (£422) to RS50,000 (£603) for ten grams of gold, along with a sudden surge in gold imports in November (around 100 tonnes of gold was imported in the days after the recall, a major spike given India’s usual rate of 500 tonnes a year).


However, the speed of the recall meant that many weren’t able to preserve their assets in this way as gold-buying businesses ended up unable to accept their notes. While business dropped by nearly 80% in jewellery shops in some areas (the main means by which Indians acquire gold), black money hoarders saw an opportunity, and began moving to acquire gold from private citizens in exchange for old currency, offering high commissions as incentives while the lack of cash left jewellery shops out of the picture. Few took them up on the offer publicly, although of course as always it’s hard to gauge how many took these deals in private.


Looking forward

Following the recall of notes, the gold price rose by 2.35% to around 87,000 rupees per ounce at its peak. Indeed, while drastic, the mass recall only briefly halted the general drop in Indian gold prices from their mid-2016 highs. Many jewellery shop owners expect business to come back stronger from the 2016 setback, as the Modi government pushes its cashless society initiatives and more customers find themselves able to pay from more stable credit or debit cards.


There are concerns, however, that another government crackdown on black money could see Indian gold owners forced to declare their gold, or hit with limits on the amount of undeclared gold that can be owned by an individual. This could cause gold demand to drop. Amendments to the income tax laws passed in late November 2016 were also rumoured to include gold ownership limits, although this was later clarified to apply only to gold that did not match the individual’s declared income. Nonetheless, by restricting the black market this legislation may reduce gold demand in India.


Globally, India is the world’s second largest gold importing nation, and the price fall currently underway could well limit price rises elsewhere, even in the face of the current geopolitical turmoil. On the other hand, Indians are just as aware of the geopolitical climate as their international contemporaries, and as recent rises in the gold price in rupees throughout 2017 have demonstrated local concerns aren’t the only thing driving Indian markets.

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