2012-04-01

Protectionism rises in India; Gold "bubble" about to burst?

Rising Risk: Foreign Firms Sense Hostility in India
Tax proposals in the national budget unveiled in March stunned foreign firms. They could create significant retroactive tax liabilities for international mergers stretching back a half-century and eliminate a tax exemption many investors now have, wreaking havoc on corporate deal making, legal experts say. More than a half-billion dollars in foreign capital has left the Indian stock market in recent days.

The government also singled out a U.K.-based oil producer for a multibillion-dollar levy that the company calls discriminatory. Internet executives from Google and Facebook are facing criminal prosecution for not removing Web content that some consider objectionable even though the companies have said they followed the letter of the law. And long-promised efforts to liberalize foreign investment in the retail, defense and insurance sectors have stalled.

Social mood is negative in India, as witnessed by stock market and current account figures.

The current account has plunged into deficit:

One reason for the high trade deficit is rising oil prices, but another reason is Indian's steady importation of gold. This is why the Indian government has raised import taxes on gold: India to review gold tax but import duty to stay
However authorities said they would not budge on an import duty hike from 2% to 4%.

India is the biggest importer of gold in the world.

...However he added that the import duty would stay because Indians were spending "precious foreign exchange" to buy gold.

The high gold imports have weakened the rupee against the major global currencies.
This is an important equation. If domestic investors are dumping their currency to buy gold, they are weakening their currency on the global market. When it reaches the level of Indian consumption/investment and it's coupled with a weak economy, it can turn into a self-fulfilling prophecy of currency "collapse," i.e. the currency could suffer a mini-crisis and decline sharply until the gold price rises enough to slow imports. The Indian government would rather have gold imports decline gradually, rather than abruptly through a financial or economic crisis.

I don't follow the Indian market or political situation closely, but the tariffs aren't very high at 4%. My expectation is that the tax will continue to increase until gold imports slow. Gold investors take heed. I put bubble in quotes at the top because I do not believe gold is in a bubble, but a drop of a few hundred dollars would catch bulls by surprise and cause naysayers to say the bubble is bursting.

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