India’s measures to curb gold imports have worked, but what now?

But the deficit is narrowing fast, according to a report published by the International Monetary Fund (IMF) this month.

“India’s external vulnerabilities have fallen significantly in recent months, helped by policy actions taken to shrink the current account and strengthen capital flows.”

The IMF expects India’s current account deficit to fall to around 3.3% of GDP this fiscal year.

The government’s measures to reduce gold imports – which include import duties of 10% and the 80:20 rule – seem to have worked.

Official statistics show that gold imports between July and October fell 63% compared with the year before, according to a recent report by the World Gold Council (WGC).

But official imports are only half the story: The Indian gold market has a number of alternative sources for obtaining the coveted metal.

Although it’s impossible to calculate exactly how much gold was smuggled into the country in response to import restrictions, the Indian Finance Minister estimates that these activities may have added between one and three tonnes per month in the second half of the year. The WGC believes this could be a considerable underestimate and that smuggling could have added as much as 200 tonnes throughout the year.

Regardless of how much illegal gold was actually brought into the country last year, the fact remains that Indians are hungry for gold. According to the WGC report demand hit 974.8 tonnes in 2013 – the third highest annual volume.

And the government’s ability to hold off imports in the long term is questionable.

“The limits on gold imports should be viewed only as a stop-gap measure and have the potential to become less effective over time (including from increased smuggling),” the IMF wrote in its India report.

“Durably lowering the demand for gold as a store of value will only be achieved through low inflation, raising real interest rates on deposits, and ensuring macroeconomic stability.”

Eroding confidence in the Indian economy, high inflation, and the rupee’s weakness – highlighted by a record low in August 2013 and exacerbated by high imports – are convincing many Indians that gold may be their best bet.

“High and persistent inflation is a key vulnerability that has caused household inflation expectations to continuously exceed actual inflation and become embedded in behaviors,” the IMF wrote. “This, in turn, has driven a rising demand for gold and is adding to downward pressures on the rupee.”

Meanwhile, India’s growth is expected to slow to 4.6% this year – the lowest level in a decade, according to the IMF.

Authorities say they can indeed sustain low gold import levels, pointing to, among other economic policies, the introduction of inflation-indexed bonds which offer households an alternative inflation hedge to gold.

But Indians have a long history with gold and the government’s attempts to convince people that they don’t need to rely on the precious metal in times of crisis has been a challenge, even in the best of times.

See the full IMF report in India here.