India - Going for Gold special report


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Our new report ‘India – Going for Gold’ examines the state of India’s economy. A combination of slowing growth, sticky inflation and wide fiscal deficit is forcing the Indian consumer to turn to gold in order to safeguard assets, causing the current account deficit to escalate to almost 5% of the GDP in fiscal year 2012/2013.

In an attempt to curb imports the government has raised import taxes on gold, most recently in January 2013. Are these measures enough to reverse this trend?

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India - Going for Gold special report

  1. 1. As India’s current-account deficit reaches record levels, concerns are growing over the country’s ability to finance this through foreign investment inflows. In his annual budget speech on February 28th India’s minister of finance, Palaniappan Chidambaram, blamed a “passion for gold” for India’s burgeoning current-account deficit, which is thought to have reached nearly 5% of Gross Domestic Product (GDP) in fiscal year 2012/13 (April-March). In terms of arithmetic, he may well have a point: India’s gold imports in 2011/12 reached US$57bn, while the current-account deficit that year was US$78bn. Since then, the government has raised import taxes on gold twice, most recently in January 2013, in a bid to curb imports. Despite the weakness of the Indian rupee and a 6% rise in the global price of gold, imports of the precious metal are thought to have fallen only slightly, to around US$55bn in 2012/13. India remains the world’s largest consumer, and importer, of the yellow metal. Gold accounts for more than 11% of India’s total import bill, surpassed only by that other precious commodity: petroleum—liquid gold. In large part, gold is bought domestically as a hedge against inflation. The finance minister acknowledged this in his budget speech, proposing the introduction of inflation- indexed government bonds to discourage the purchase of gold. Such a measure may go some way towards easing the import bill, but does not address the fundamental concerns plaguing the Indian economy: a wide fiscal deficit and inflation. Thus far, financing this fiscal deficit has not been difficult for the government. Banks are required to invest at least 23% of their deposits in government securities, providing the administration with a captive market domestically for its debt. However, this system, while allowing the government to easily finance its deficit, removes a sense of urgency from the monumental task of growing India’s abysmally low tax-take (India has one of the lowest tax-to-GDP ratios in the world, at just 11%) and reining in spending. With private-sector financing and investment being crowded out, growth has slumped. In October-December 2012 real GDP growth fell to 5% year on year—the slowest pace of expansion in a decade. However, inflation remains stubbornly high, and the Reserve Bank of India (RBI, the central bank) has had limited room to ease policy in order to boost growth. Meanwhile, despite the government’s efforts since September 2012 to rein in the fuel subsidy bill, they remain generous, and imports of fuel have continued unabated. Faced with the combination of slowing growth, sticky inflation and a wide fiscal deficit, the Indian consumer can hardly be faulted for turning to gold to safeguard his assets, and the current-account deficit continues to widen. Thus far, India has not had any difficulty in securing the level of foreign inflows needed to finance the deficit. The last time India faced a balance-of- payments crisis (in 1991), its hard-currency reserves had fallen to US$600m and it could barely finance three weeks worth of imports. At present, however, the currency is free- floating and foreign-exchange reserves stand at close to US$300bn, making that sort of crisis unlikely. Nevertheless, this lust for gold puts pressure on India’s external balance, as it needs to finance these imports, while parking growing amounts of household wealth in unproductive assets. Reversing this trend will require structural reforms and fiscal consolidation, rather than simply curbing the supply of gold. Sponsored by: IndiaGoin g for gold Faced withthe combination ofslowing growth, stickyinflationand a wide fiscaldeficit,the Indian consumercan hardly befaultedforturningto gold to safeguard hisassets,and the current-accountdeficit continuesto widen.
  2. 2. India’s economic performance in the year ending March 31st has been lacklustre, prompting much handwringing from business leaders and government officials. High inflation— consumer price inflation (CPI) averaged 10.4% year on year in January-February 2013—tight credit conditions, a poor monsoon and political and regulatory instability have all been blamed for the slump. According to the Central Statistical Organisation (CSO), real GDP growth (on a factor- cost basis) slowed to around 5% in fiscal year 2012/13 (April- March), marking the slowest pace of growth in a decade. Although this pace of growth compares favourably with other countries, it is insufficient to meet India’s ambitions: at around US$1,500, India’s per capita GDP is less than one- quarter of China’s (around US$6,100) and just over one-half that of neighbouring Sri Lanka (US$2,900). Both domestic and international factors hampered India’s growth in 2012/13. A poor monsoon led to a slowing of agricultural output growth, to 1.8%, from 3.7% in 2011/12. Limited progress has been made on improving irrigation, with over 60% of agricultural land being rain-fed. However, attempts are being made to improve the agriculture supply chain, particularly by inviting investment from foreign retailers. These reforms have been politically contentious, and although the government allowed investment by foreign multi-brand retail firms, such as Walmart and Carrefour in late 2012, it has left the eventual approval to individual state governments. Should state governments proceed with allowing foreign investment, it could have a significant impact on growth in the medium term. The agriculture sector accounts for less than 17% of GDP, but employs over one-half of the labour force. If investment in agriculture leads to higher levels of productivity, it will boost rural incomes, thereby providing a fillip to domestic demand. In turn, this will boost the prospects for India’s industrial sector, as a growing rural middle-class increases its spending on goods such as cars and consumer goods. However, as long as agriculture is largely rain-fed, the sector will remain vulnerable to poor or unevenly distributed monsoon rains. Government plans to increase the area of irrigated land will be expensive, and if projections of decreasing water availability prove correct, the sector may struggle in the long term. The agricultural sector is forecast to grow by around 3% a year between 2013/14 and 2017/18. This rate of growth implies that the decline in the proportion of GDP accounted for by agriculture will continue: the share is forecast to slip to 14% by 2017/18. Many parts of India’s industrial sector recovered strongly following the 2008-09 global financial and economic crisis, with growth averaging over 9% in the period between 2009/10 and 2010/11. In the next two years however, industrial output slumped, growing by only 3.1% on average. The mining sector, in particular, has been affected by regulatory delays in obtaining permits and land clearances, as well as allegations of graft in 2012, which resulted in further delays in project approvals. Ensuring that land, power and infrastructure are available for industries is key to raising India’s growth rate in the medium term. The sector will also be an important means of providing employment for some of the 10m people who enter the labour force each year. Thanks to tight cost controls, and also to increases in scale and competitiveness, many parts of the manufacturing sector, including capital goods, automotive and pharmaceuticals, will perform well in the forecast period. Annual growth in the industrial sector will average 6% during the next five years, and industry’s share of GDP will decline slightly to 25.1%, from 26.7% at present. © The Economist Intelligence Unit Limited 2013 Macroeconomic overview 2 0 1 2 Population 1.22 bn GDP US$ 1,978 bn Real GDP growth 5% Exchange rate LCU:US$ (av) 53.4 Budget balance -5.4% Consumer price inflation 9.3% Stockmarket index 19,426.71 Current-account balance -4.8% Gross domestic product (annual percentage change) Source: Economist Intelligence Unit 2013 Budget balance (% of GDP) Source: Economist Intelligence Unit 2013 Lookingforsilver linings India 2007 0.0 2.0 4.0 6.0 8.0 10.0 12.0 2008 2009 2010 2011 2012 2007 -6.00 -7.00 -5.00 -4.00 -3.00 -2.00 -1.00 0.00 2008 2009 2010 2011 2012
  3. 3. © The Economist Intelligence Unit Limited 2013 The services sector—the bulwark of the economy, which accounts for over one-half of total GDP—also slowed, growing by 6.7% this year, down from an average of 9.5% in the 2003/04 to 2011/12 period. Nevertheless, the sector will remain the main engine of economic growth in India in the medium term. The slowdown in 2012/13 is largely attributable to a decline in private income and consumption. The financial services sector, which accounts for nearly one-third of all services, slowed to 8.6%, from 11.7% in 2011/12. With the Reserve Bank of India (RBI, the central bank) adopting a more accommodative monetary policy stance since the start of 2013, and the government attempting to liberalise the banking and pensions sector, The Economist Intelligence Unit expects this subsector to rebound between 2013/14 and 2017/18. Overall service- sector growth will be driven by already strong areas of activity, such as telecommunications, as well as by services in numerous high-potential but currently under-served areas, including healthcare, retailing, hospitality and education. In particular, IT and IT-enabled services (ITES) will remain major sources of export revenue. The positive effects of past economic reforms, together with demand for ITES, will continue to contribute to a structural shift towards strong growth for India’s economy. Services will be the fastest-growing sector of the economy in the forecast period, expanding by 8.6% per year on average, and its share of GDP will consequently rise to 60.5% by 2017/18, from 56% at present. After several false starts, since September 2012 the government has undertaken a series of reforms to tackle the burgeoning fiscal deficit and to create new jobs. These include the raising of administered fuel prices and the easing of restrictions on foreign investment in leading sectors, including retail and aviation. But with the next general election a little over a year away, progress on structural economic reform before then will be limited. Regardless of which of the two main parties heads the next government, the rise of state-level and regional parties will mean that the winning party is likely to govern in a coalition (which has been the norm in India for the past two decades). Therefore, the pace of reform in 2014-17 will also be tempered by coalition politics and opposition from vested interests. Between 2013/14 and 2017/18, an improvement in business and investor sentiment, as well as monetary policy loosening, will enable real GDP growth to rebound to 7.2% per year on average. India’s strong fundamentals—high savings and investment rates, rapid workforce growth and a quickly expanding middle class—will continue to boost economic growth. However, a shortage of skilled labour, infrastructure bottlenecks and the difficulties involved in moving from low-productivity agriculture to high- productivity manufacturing will constrain GDP expansion, which will remain well below potential. Between 2013/14 and 2017/18, an improvement in business and investor sentiment, as well as monetary policy loosening, will enable real GDP growth to rebound to 7.2% per year on average. Public debt (% of GDP) Source: Economist Intelligence Unit 2013 Current-account balance (% of GDP) Source: Economist Intelligence Unit 2013 2007 -6.0 -5.0 -4.0 -3.0 -2.0 -1.0 0.0 2008 2009 2010 2011 2012 2007 46.0 48.0 50.0 52.0 54.0 56.0 58.0 2008 2009 2010 2011 2012
  4. 4. About Aberdeen Asset Management Aberdeen Asset Management PLC is a global investment group, managing assets for both private and institutional clients from offices around the world. The group’s headquarters is in Aberdeen but we prefer to locate our fund managers near the companies and markets in which they invest. Aberdeen manages or advises 14 closed-end funds for U.S. investors with more than $ 6 billion in assets. For more information about Aberdeen’s closed-end funds, please visit Important Information Gross Domestic Product (GDP) is the market value of all officially recognized final goods and services produced within a country in a given period of time. This report is sponsored by Aberdeen Asset Management but authored solely by the Economist Intelligence Unit and reflects EIU proprietary analysis of a country’s economic environment and prospects for the future, as well as macroeconomic data and EIU rankings. This article does not imply any partnership, agency or joint venture relationship with Aberdeen Asset Management. While every effort has been taken to verify the accuracy of this information, neither the EIU nor the sponsor of this report can accept any responsibility or liability for reliance by any person on this report or any of the information, opinions or conclusions set out in the report. Some of the information in this document may contain projections or other forward-looking statements regarding future events or future financial performance of countries, markets or companies. These statements are only projections and actual events or results may differ materially. The reader must make his / her assessment of the relevance, accuracy and adequacy of this information contained in this document and makes such independent investigations, as he or she may consider necessary or appropriate for the purpose of such assessment. International investing entails special risk considerations, including currency fluctuations, lower liquidity, economic and political risks, and differences in accounting methods; these risks are generally heightened for emerging market investments. There are also risks associated with investing in India. Concentrating investments in a particular region and/or country subjects the investment to more volatility and greater risk of loss than a more geographically diverse investment. Aberdeen Asset Management Inc., a wholly-owned subsidiary of Aberdeen Asset Management PLC, is an investment adviser under the Investment Adviser’s Act of 1940. “Aberdeen” is a U.S. registered servce mark of Aberdeen Asset Management PLC. The information in this report is accurate as of April 2013. About the Economist Intelligence Unit The Economist Intelligence Unit (EIU) is the world's leading resource for economic and business research, forecasting and analysis. It provides accurate and impartial intelligence for companies, government agencies, financial institutions and academic organisations around the globe, inspiring business leaders to act with confidence since 1946. EIU products include its flagship Country Reports service, providing political and economic analysis for 195 countries, and a portfolio of subscription-based data and forecasting services. The company also undertakes bespoke research and analysis projects on individual markets and business sectors. More information is available at or follow us on