India gold duty hike sparks 6% surge, raises demand, smuggling fears

Indian gold prices surged on Wednesday after the government raised import duty on the precious metal.

The Centre increased the import duties on gold, silver, and other precious metals, raising the total duty from 6% to 15%.

This new structure, effective from May 13, is composed of a 10% basic customs duty and a 5% Agriculture Infrastructure and Development Cess (AIDC).

Immediate market reaction

At the time of writing, the most-active gold contract on India’s Multi-Commodity Exchange was at INR 162,831 per 10 grams, up nearly 6% from the previous close.

This morning, the contract had edged up nearly INR 9,000.

The silver contract on MCX was at INR 295,746 per 1 kg, up 6% from the previous close. The contract had risen to INR 301,429 per kg earlier in the day.

In Mumbai’s spot market, gold with a 99.9% purity opened at INR 160,411 per 10 grams, a whopping jump from INR 151,954 per 10 grams from Tuesday’s close, according to IBJA’s data.

Meanwhile, silver with a 99.9% purity opened at INR 286,850 per kg compared to Tuesday’s close of INR 267,820 per kg.

Overall demand is expected to drop by almost 10%, with the jewellery business alone potentially seeing a 5–7% decline, Surendra Mehta, national secretary of the Indian Bullion and Jewellers Association (IBJA), was quoted as saying in a Moneycontrol report.

Government rationale and demand impact

Two days after Prime Minister Narendra Modi urged austerity, the Centre took action to alleviate strain on foreign exchange reserves and restrict imports.

This move addresses the increasing import bill and pressures related to the Iran war.

“Prime Minister Modi’s calls to conserve energy and avoid gold are more of a drastic precautionary intervention in the hope that India can conserve US dollars for the ability to import more crude oil as costs continue to rise,” Iván Marchena, senior economist at Just2Trade, a global brokerage company, told Invezz.

Because India imports over 90% of its gold at a cost of billions of dollars, more USD leaves the country without helping to support domestic productivity.

IBJA’s Mehta expressed concern that the government’s decision could lead to an increase in smuggling, stating, "Illegal import is possible, which will help non-genuine businessmen."

He also noted that higher discounts on gold purchases would persist in the market.

The increase in import duties is expected to raise the landed cost of bullion, according to commodity experts.

This comes as gold constitutes 9% of India's total imports. 

While these import curbs could potentially boost the rupee and forex reserves, the population might turn to gold loans against their jewellery as a way to manage inflationary pressures.

Pricing mechanics and future outlook

Nirpendra Yadav, senior commodity research analyst at Bonanza, stated that the rise in the import duty would have an immediate impact on gold and silver prices on the MCX.

Yadav added that MCX prices usually rose sharply because imported bullion became costlier, domestic prices started trading at a bigger premium over international COMEX/LBMA prices, and futures contracts on MCX quickly adjusted to reflect the higher import cost.

According to Yadav, a customs duty increase could drive up MCX gold prices, even if Comex gold remains steady.

He explained that the MCX pricing formula is approximately calculated as: International Price + USD/INR + Import Duty + Taxes + Premium.

Therefore, an increase in customs duty alone has the potential to raise MCX prices, even with a stable COMEX gold price.

According to Yadav, a short-term duty increase is likely to result in a strong domestic premium, a short-covering rally, and a wider arbitrage gap between MCX and COMEX.

However, escalating prices also carry the risk of profit-taking and reduced demand. Jewellers might curb their buying, causing physical premiums to decrease later on.

Over the medium term, higher duties are expected to decrease official bullion imports, which would bolster the rupee and improve the current account deficit. Nevertheless, slowed jewellery demand could potentially lead to an increase in smuggling activities.

A 1% increase in the import duty on gold leads to a reduction of about 6.4 tonnes in consumer gold demand, based on data from the World Gold Council.