Sliding gold prices dampen India's firepower on imports

By Rajendra Jadhav and Siddesh Mayenkar

MUMBAI (Reuters) - Falling gold prices pose a dilemma for India's government as it searches for ways to show in its February 28 budget it can control a record current account deficit.

The government has already targeted gold, second only to oil in value of imports, by hiking the duty to 6 percent from 4 percent on January 21, and could lift the tariff again on Thursday.

But since the last hike, prices in India have fallen by nearly 4 percent, potentially boosting demand, and an austere budget that leads to a stronger rupee could also lower domestic prices. Further tariff increases could stem the legal flow at a risk of increased smuggling.

"For months people were waiting for prices to go below 30,000 rupees. Those people will now enter the market," said Prithviraj Kothari, director with RiddiSiddhi Bullions Ltd, a wholesaler in Mumbai.

The benchmark gold contract on India's Multi Commodity Exchange hit a seven-month low of 29,263 rupees on February 21, and traded at 29,575 rupees per 10 grams on Monday.

"If prices fall sharply, say to 26,000 rupees, India would import more gold in 2013 than it had imported in 2012," said Kothari, a former head of Bombay Bullion Association (BBA), the main importers' body.

Trade Minister Anand Sharma said last week that he was discussing further curbs on gold imports with Finance Minister P. Chidambaram, who will present what is expected to be an austere budget for 2013/14 on February 28.

Measures can also be announced outside the budget.

Chidambaram needs to tame a current account deficit that hit a record high of 5.4 percent of gross domestic product in July-September. That has driven the rupee down and forces India to rely on volatile foreign fund flows to pay for imports.

So speculation is rife among traders that India could raise the import duty to as much as 8 percent.

But this could encourage smuggling. As it stands, the duty on 100 grams already covers the cost of an airfare to Dubai.

"Smuggling has increased....Customs and the Directorate of Revenue Intelligence have seized gold smuggled at airports," said Mohit Kamboj, current president of the BBA.

Another challenge for Chidambaram is that a tough budget may strengthen the rupee, an important factor in the local cost of gold.

"The government is planning to cut down the fiscal deficit, which would support the rupee. And if the rupee strengthens, effectively it will bring down gold prices," said a Mumbai-based dealer with a private bullion importing bank.

Gold's attraction continues to be underpinned for India's billion-plus population not just by tradition, but also because of high inflation that eats into meagre savings rates.

The World Gold Council forecasts demand could rise nearly 12 percent to as much as 965 tonnes this year, almost all of which would be imported.

"The government should explore other options like unlocking the thousands of tonnes of gold held by households," RiddiSiddhi Bullions' Kothari said.

India is home to about 20,000 tonnes of gold holdings - more than double those of the U.S. Federal Reserve - much of it with rural households in the form of jewellery or bars.

India's central bank has said it would consider setting up a special "gold bank" that would buy gold from individuals at much higher rates to help liquidate these idle stocks.

(Editing by Jo Winterbottom and Michael Urquhart)