Not a solution

Gold, oil prices may bring only temporary relief

The sharp decline in the price of gold over the past few days has caused a perceptible feeling of relief in parts of India. India is apparently addicted to gold and oil imports, and the high prices of those commodities were putting an increasingly onerous burden on the economy. Gold is now down more than a quarter from its highest worldwide price, in September 2011; this is, in fact, the lowest it has been in two years. Meanwhile, the price of a barrel of Brent crude oil seemed to be heading straight towards $100 from a territory closer to $115.

The relief these circumstances afford Indian policymakers is severely limited, however. The primary causes of India's economic meltdown are not high crude or gold prices. The best that can be hoped from this fall in prices is that it will provide temporary relief on external payments. Not that this is a small thing - after all, the current account deficit in the last reported quarter was a quite extraordinary 6.7 per cent of gross domestic product. But whether this relief on the external account will be sustained over time is open to question; indeed, even the size of this relief is uncertain. After all, one popular explanation for the decrease in the prices of these commodities is that the long reign of liquidity-induced premiums in commodity markets is over. If that is the case, however, that gold prices are falling because there is reduced liquidity, then surely capital flows to emerging economies including India will also be lower, thanks to that same reduced liquidity. In which case, since India is dependent on capital flows to finance its current account deficit, what is the overall effect on its external vulnerability?

On the other hand, there is good reason to suppose that while gold prices are lower than they have been for some time, the structural reasons that kept gold high have not disappeared. Gold is a risk hedge; it has declined in real value in the years - decades - when risk is low and the financial system appears strong. It is far from likely that the world is entering another such period now. Oil prices, too, are subject to fluctuations on the basis of risk, except here the risk factors are political. However there is little doubt that, with the coming energy-independence of a United States discovering shale gas, and a stagnating Europe, the long-term outlook for oil prices isn't too bad. But that lies in the future; in the short- and medium-term, oil could easily go back up.

Thus, it would not be wise to suppose that India's problems on the external account are likely to be over. Remember, the collapse of India's exports is as potent a driver of the current account deficit as anything else. New Delhi must continue to try and recover India's industrial sector, so that exports grow. In addition, there must be no pause in the phasing out of diesel subsidies. One change, though, that the government could consider making is reducing the heavy customs duty on gold, which has gone from zero to six per cent in the past year. There is increasing evidence of a smuggling infrastructure being built up, especially on the Nepal and Bangladesh border - 36 kilos of unmarked gold bars were seized on the latter this past weekend.