India Urges Resisting Gold as Curbs Fail to Stem Currency Slump

Indian policy makers are urging citizens to resist buying gold and boosting scrutiny of speculative currency trades after import curbs and dollar sales failed to stem the world’s biggest currency loss.

The rupee fell 4.9 percent last month, the worst performance among 78 global currencies tracked by Bloomberg, as the Federal Reserve signaled it may pare stimulus measures this year. The currency plunged to an all-time low of 60.7650 per dollar on June 26. Standard Chartered Plc and Credit Suisse Group AG predict a decline to around 62 in a year.

Global funds pulled $7.1 billion from Indian stocks and bonds last month through June 27, leaving the rupee vulnerable to a record current-account deficit, even as the government allowed them to buy more sovereign debt. Graft allegations delayed plans to allow foreign companies to invest more in Asia’s No. 3 economy. Some jewelers plan to stop selling gold coins and bars after Finance Minister Palaniappan Chidambaram asked the biggest bullion-consuming nation to forego the “temptation” and help rein in imports that hurt the currency.

“Policy makers have been resorting to persuasive techniques to stem the rupee’s fall, while much bolder, reformist, steps need to be taken,” Manik Narain, a strategist at UBS AG in London, said in an e-mail interview on June 26. “There is a real worry among foreign investors that the government will implement meaningful reforms only glacially ahead of elections next year.”

‘Produce Mandate’

The Reserve Bank of India said June 26 overseas funds must “produce a clear mandate” from thier clients to hedge exposure to the rupee using derivatives, and banks must verify that investors hold the underlying local securities. The statement indicated that the central bank is seeking to check currency speculation, according to IndusInd Bank Ltd.

The RBI has also enquired about foreign banks’ open positions involving the rupee, though the lenders haven’t been asked to unwind the trades, said two people familiar with the matter, who asked not to be named as the information isn’t public.

“The RBI wants to be seen to be doing something,” J. Moses Harding, executive vice president at IndusInd in Mumbai, said in a June 27 telephone interview. The authority “can do nothing” about such trades as long as rules are being followed, he said.

Record Deficit

Finance Minister Chidambaram estimates India needs more than $75 billion in the fiscal year through March 2014 to finance its current-account deficit. The shortfall in the broadest measure of trade widened to a record 4.8 percent of gross domestic product in the year ended March 31 from 4.2 percent in the previous period, official data show. The RBI has said gold imports account for 80 percent of the gap.

The central bank estimates the sustainable level of the deficit at 2.5 percent of GDP and says the gap is the biggest risk to India’s economy, which grew 5 percent in the last fiscal year, the least in a decade. Standard & Poor’s has said weakness in growth and investment put the nation at risk of losing its investment-grade credit rating.

India has raised bullion import tariffs fourfold from January 2012, prompting the World Gold Council to say June 6 that further increases may boost illegal trade. The central bank placed restrictions on overseas purchases on a consignment basis and limited imports for local use against cash only.

‘Resist Temptation’

Even so, gold imports surged in April and May as buyers thronged shops for ornaments after bullion entered a bear market last quarter, prompting Chidambaram on June 13 to urge Indians “to resist the temptation.” The metal’s use is deeply rooted in the nation’s culture and tradition, and import curbs may not significantly dent demand, Prem Hinduja, chief executive officer of jeweler Tribhovandas Bhimji Zaveri Ltd., said in a June 14 interview.

The All India Gems & Jewellery Trade Federation, which represents about 300,000 businesses, said June 24 it will ask members to suspend sales of coins and bars to retail investors.

“We are of the view that if the government is worried, we as responsible citizens must help the government,” Bachhraj Bamalwa, a director at the Federation, said in a June 26 telephone interview. “We want to tell the government that increasing import duties, putting curbs on imports is not the solution.”

Corruption Scandals

The rupee also weakened as a series of corruption scandals roiled Prime Minister Manmohan Singh’s coalition and disrupted parliament this year, derailing efforts to revive investment and boost growth before general elections in 2014. Bills to simplify taxes and allowing foreign investment in the pensions and insurance industries stalled, as inflation risks posed by the currency’s weakness prevent the RBI from adding to three interest-rate cuts this year.

The RBI on June 17 left its benchmark rate unchanged for the first time this year, saying it would need evidence of a “durable” cooling of inflation and a stabilizing of flows that hurt India’s balance of payments.

While the latest rupee drop isn’t triggered by India’s economic fundamentals, the currency’s weakness can lead to concerns about a financial crisis, Anubhuti Sahay, an economist with Standard Chartered in Mumbai, said in a July 1 telephone interview.

Global funds cut holdings of local bonds by $5.4 billion last month through June 27, latest exchange data show, after adding in each of the previous six months, and are set to snap 12 months of net-buying in equities. The yield premium offered by 10-year Indian sovereign debt over similar-maturity U.S. Treasuries has fallen 125 basis points from this year’s high of 622 on April 5.

Trigger Backlash

Policy makers can do little to stem the fund outflow, because moves such as raising interest rates to make yields more attractive aren’t feasible given weak growth, Irene Cheung, a strategist at Australia and New Zealand Banking Group Ltd. in Singapore, said in a June 27 research report. Banning gold imports will trigger a public backlash and capital controls will have a “devastating” impact on investor confidence, she wrote.

The rupee pared its monthly loss as it surged 1.4 percent on June 28, the most since September, after comments by Fed officials prompted investors to reassess their expectations for a reduction in U.S. stimulus and India’s government agreed to double natural gas prices effective April 2014. Its 8.6 percent loss last quarter is the biggest since September 2011.

New York Fed President William C. Dudley said June 27 unprecedented U.S. bond purchases could be prolonged should the world’s biggest economy fail to meet forecasts. India’s cabinet on June 27 agreed to link natural-gas prices to global benchmarks to encourage exploration. The move will cut reliance on imports in the medium term, according to FirstRand Ltd.

‘Still Keen’

“This shows that the government is still keen on reform,” Harihar Krishnamoorthy, treasurer at the Indian unit of FirstRand in Mumbai, said in a June 28 telephone interview. “The rupee should see a more steady correction from here.”

Krishnamoorthy predicts the currency will climb to 59 per dollar in coming weeks and extend gains to between 58 to 56 this year. The rupee rose 0.2 percent to 59.4200 as of 11:45 a.m. in Mumbai.

A sustainable strengthening of the rupee will need a pick-up in foreign-direct investment rather than risk-dependent portfolio inflows, according to Citigroup Inc. With Prime Minister Manmohan Singh’s Congress party lacking a majority in parliament, the government will find it tough to overhaul labor and land-acquisition laws, the lender predicts.

‘Limited Firepower’

Net direct investment fell to $19.8 billion in the year ended March 31 from $22.1 billion 12 months earlier, while portfolio flows increased to $26.7 billion from $16.6 billion, official data show. Foreign reserves stood at $287.8 billion as of June 21, down from an all-time high of $321 billion in 2011. That’s just enough to cover about six months of imports and limits the RBI’s ability to intervene, Citigroup estimates.

“The measures which can help to revive the investment cycle, draw in foreign investments over the medium-to-long term and boost the export industry are politically difficult and unpopular with the electorate,” Citigroup analysts, including Singapore-based Gaurav Garg, wrote in a June 27 research report. “The government has very limited firepower.”