As Gold Prices Hit New Highs, A Higher Import Bill Looms Ahead

India's trade deficit increased in August, driven by a rise in gold imports. Despite this, gold imports are not expected to impact merchandise imports as heavily in the future, though risks to the trade deficit remain.

The trade deficit expanded to $29.65 billion in August, up from $23.5 billion in July. Imports for the month grew by 3.3% year-on-year, reaching $64.4 billion, with gold imports at $10 billion, a 103.7% increase compared to the previous year. This spike was attributed to a reduction in customs duties on gold, which has continued to rise, now priced at approximately $2,672 an ounce.

Madhavi Arora, lead economist at Emkay, said that gold imports might normalise after being frontloaded in August. The surge was prompted by the union budget's announcement reducing import duties from 15% to 6%, and stocking ahead of the festive season. She noted that it remains to be seen whether this was a one-off event and whether gold imports would average $3 billion per month, staying below $50 billion for the fiscal year.

Dhiraj Nim, economist at ANZ Research, agreed that August's gold imports are likely to be an anomaly due to the customs duty cut. He predicted the current account deficit would average around $23 billion for the rest of the fiscal year. He also mentioned that the export-import ratio for oil has worsened due to reduced exports and imports. While lower oil prices have a positive effect, it is less pronounced.

The World Gold Council said that the current economic environment is difficult to interpret due to conflicting data. The upcoming US election adds to this uncertainty, which has likely led to an increase in investors using the options market to express their views. Gold ‘spreading’ positions in options, typically a less active area, have reached multi-year highs, suggesting that investors are either hedging or speculating on both potential interest rate cuts and the election outcome.

While exports started the fiscal year strongly, they contracted in July and August. Crisil attributed this to factors such as container shortages caused by trade-route disruptions and the US' anticipated tariff hikes on Chinese exports.

Imports have grown faster than exports, widening the trade deficit. This trend is likely to continue, especially as the US has increased tariffs on Chinese imports. Along with the economic slowdown in China, this may lead to dumping in larger Asian markets, including India, explained DK Joshi, Crisil’s chief economist.

Recently, there has been an increase in steel imports from China and Vietnam, making the merchandise trade deficit an area of concern. However, the surplus in services trade and strong remittance flows offer some relief and are expected to keep the current account in a manageable position.

Arora stated, "We maintain that the current account deficit for the fiscal 2024-25 is likely to be 1.1-1.2% of GDP." Emkay expects non-oil exports to decline by 4%, while non-oil imports are projected to grow by less than 2% in fiscal 2025 after contracting by 1.6% in the fiscal 2024. She added that the goods trade deficit as a percentage of GDP could be around 6.9%, similar to the financial year-ended March 2024, though lower crude prices may reduce this risk.

Arora also highlighted that strong services exports, particularly in IT and GCC-led business consulting and financial services, have supported the current account.

Although equity capital flows might moderate in 2024-25, with debt flows from JPMorgan’s index increasing, the Balance of Payments surplus is expected to stay comfortable at $28-30 billion, though it will be less than half of 2023-24's levels.

Foreign Direct Investment flows will remain uncertain, especially with slower global growth in FDI. However, India continues to be the top destination for global greenfield projects, and flows may improve, despite a slowdown in the fiscal 2024. Arora concluded, "Overall, we expect external fundamentals to remain stable, with manageable financing needs."