India's Rates Rise With Gold Prices

04/12/2010 1:00 am EST

Focus: GLOBAL

David Coffin

Editor, Hard Rock Analyst

The appreciating rupee could revive India’s appetite for gold, write David and Eric Coffin of The Hard Rock Analyst.

[The recent] 0.25% increase to India’s bank rate coincided with a major reversal in the currency markets. The rupee (INR) closed out the day even against the US dollar, which had reversed its recent slide, and gained against most other currencies.

Over the past year the rupee has strengthened steadily relative to the greenback, so Indians have seen about 10% chipped off the dollar-based gains for global goods through that period. Still, the current rupee/dollar exchange rate of 45 is only a recovery of about half the losses the rupee suffered relative to the dollar as the ratio moved from a sub-40/1 rate in early 2008 to the 51/1 low a year ago.

The 25-basis-point [rate hike] by the Reserve Bank of India (RBI) brings its repo rate up to 5.0%. Prime rates for India’s larger commercial banks generally range from 11.5% to 13%, and while this central bank move hadn’t been expected before April, India’s inflation rate near 10% was expected to boost commercial prime rates regardless of what the central bank did.

Strong growth, and perhaps simply urban expansion that is putting cash into farmers’ hands in exchange for their land, is part of the inflation driver in India. However, the inflation rate on food was running at over 16% in February due to the recent poor weather. Better harvests in the current season could ease inflationary pressure.

There is concern that tightening by the RBI signals India will join China in moves to dampen growth rates. While China may be worried about overheating, the concern in India does seem to be centered on inflation and the fact that its bank rate isn’t reflecting it.

India’s inflation rate reflects gains for imported oil over the past 12 months, as well as the one-off (hopefully) gains to domestic food costs. If resource prices stabilize at current levels, which seems likely given weak economies elsewhere, that would also help ease inflation. How does this impact the gold watch we have on India?

In India, the gold price has moved from 48,000 rupees an ounce a year ago to a peak of 56,000 in early December, a gain of almost 17%, and now sits at about 50,000 rupees per ounce. Simply holding gold for the past year would have netted a 4% gain in rupee terms. Given the combination of a post-crunch psychology followed by sharp gains for foodstuffs, the buyers’ strike in India’s retail gold market last year is understandable.

It does not change the fact that Indian banks offer term deposits banked by deposited gold in amounts as small as 500 grams. The interest rates on these at 1% for a three-year term are admittedly meager, but they do allow capital to be redeployed and are rather better than paying to store yellow metal holdings, as happens elsewhere. We don’t know when retail sentiment in India could shift back to a buying mood for the yellow metal, but if the rupee continues to strengthen on the back of interest-rate gains, the system is still firmly in place for it to do so. We continue to view shifts to India’s retail trade as an important part of assessing gold’s price moves.

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