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Why India’s increased gold demand drives currency depreciation

Sr Emerging Markets Analyst

Will India's gold import restrictions affect credit in India? (Part 2 of 2)

(Continued from Part 1)

India is the largest gold importer in the world, yet the government continues adding limitations to importing gold into India

The Indian economy has struggled given supply constrained growth. This means that consumer demand is present, but production capacity just isn’t enough to meet the demand.

The main culprit for this struggle is a lack of investment in basic infrastructure projects to improve distribution logistics and energy supply. Recent PMI reports consistently cite power cuts as reasons why production has suffered despite existing demand.

Stronger gold, weaker currency

Another important reason for India’s struggle is that the increased demand for gold replaces the demand for hard currency, which exacerbates currency depreciation. The weaker currency has several effects, including higher inflation and lower repayment capacity of foreign currency–denominated debt.

The rupee has continued to depreciate due to several factors. Aside from the gold demand, the diminished growth expectations have led a drop in the equities markets, which bleeds funds from investors—including international investors that had to buy rupees to invest in the market and are now selling rupees to cash out. This adds additional downside pressure to the rupee.

The gold import measures, however, feel more like a short-term patch work than a solution addressing the structural changes needed in the economy.

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