Estimating elasticity of import demand for gold in India

Abstract

In India gold imports act as a huge burden on the country's current account balance and a large part of it lies idle in the economy. The attempts to curb the import demand have often failed in recent past. We explore the reasons of such failures by analyzing the gold demand pattern of India. In India gold is viewed not only as a consumption good and a financial asset; it also has a socio cultural dimension since ages. This paper derives the price and income elasticities of physical import demand for gold by taking these factors in account, which is unique in its scope. Unlike previous studies gold imports used for different purposes (jewellery, bar etc.) are analysed separately. The possibility of habit formation and inventory adjustment in determining the dynamics of India's import demand for gold have also been taken into consideration. Our findings suggest: first, different motives play roles in shaping demand for different forms of gold, although investment behaviour dominates over habit persistence in aggregate; second, given that the import demand for gold bars is inelastic with respect to real price, ceteris paribus, in both the short-run and the long-run, increment of tariff rates would not reduce import of other non-monetary unwrought forms of gold substantially; third, change in tariff rates, however, can bring down gold jewellery demand more in the long-run than in the short-run; fourth, expenditure effect is strong for gold jewellery demand while demand for gold bars responds little to any changes in import expenditure in the long-run and total gold demand is however moderately sensitive to expenditure movements. The results have important implications for anti-inflationary and anti-cyclical policymaking.