Gold use in India, the world’s biggest buyer, may climb for the first time in three years as rising incomes and inflation boost investment demand, undermining efforts to narrow a record current-account deficit.

Consumption may total 865 metric tons to 960 tons this year, compared with 864.2 tons in 2012, Somasundaram P.R., managing director of the World Gold Council for India, said in an interview in Mumbai. The gain in imports will match the increase in demand, he said. The country imported 860 tons last year, according to data from the council.

India has tripled the tax on imports since the start of 2012 to moderate demand as gold accounted for almost 80 percent of the current-account deficit, the broadest measure of trade. Gold rallied for 12 straight years, driven in part by demand from investors looking for a store of wealth amid concern about inflation. Goldman Sachs Group Inc. predicts the rally will end as a U.S. economic recovery gathers momentum.

“Imports should be higher this year according to initial estimates based on the trend in the fourth quarter of last year and as the economy grows,” Somasundaram said. “There is a sense of optimism in the economy and we can feel it.”

Consumption in India surged 41 percent to 261.9 tons in the quarter ended December from a year earlier, data from the council showed. Demand for jewelry rose 35 percent, while investment in coins and bars jumped 51 percent, it said.

Reviving growth

Finance Minister P. Chidambaram has taken steps in recent months to open the economy to more foreign investment, spur exports and speed up stalled road and rail projects to revive the weakest economic growth in a decade. The Reserve Bank of India cut the benchmark interest rate for a second time on March 19. The window for further cuts may close unless consumer inflation of almost 11 percent and a record current-account gap abate, according to Deutsche Bank AG.

Somasundaram P.R.

“While the current-account deficit is a serious issue, increasing the duty and trying to stop gold demand is not the positive way and is not going to yield results,” Somasundaram said. The U.S. economy is showing signs of improvement and will in turn boost exports from India, helping cut the current- account shortfall, he said.

“Demand should be supported by multiple structural factors, including inflation concerns and income growth,” James Steel, an analyst at HSBC Securities (USA) Inc., said in a March 18 report, referring to India’s gold consumption. “A stronger rupee would lower gold prices in local currency terms, thereby boosting demand.”

Worrying inflation

Inflation in India has averaged almost 9 percent in the three years through 2012, prompting the central bank to raise interest rates 13 times as government spending fueled price gains. Consumer prices are rising almost 11 percent, or at a record pace, and inflation continues to be “a worry,” Finance Minister Chidambaram said in a March 15 interview.

Any decline in Indian gold demand is cyclical and the metal will remain a preferred asset, Sanjay Mathur, Singapore-based head of economic research at RBS, said in a report on March 14. “Negative real deposit rates accentuate the appeal for gold as an alternate investment,” he said.

Gold is a critical and predominant form of saving in rural India, which makes up about 70 percent of the population, according to Nilesh Mundra, head of investment strategy for private banking at ICICI Bank Ltd., The nation’s second-largest lender by assets estimates households hold $1.1 trillion of gold, which accounts for about 7 percent of their total wealth.

Wedding demand

Buying gold is considered auspicious in India during religious festivals and weddings. The festivals start in August and end in November, and are followed by the wedding season.

Around 50 percent of the country’s population is under 25, with 15 million weddings estimated every year till 2020, equivalent to about 500 tons of fresh gold demand, according to ICICI’s Mundra. Gold forms 30 percent to 50 percent of total marriage expenses, he said.

Gold has fallen 4.1 percent this year to US$1,608.33 (RM5,020) an ounce on speculation the U.S. Federal Reserve will pare its stimulus program. The decline has turned some investors away, Kishore Narne, head of commodities and currency at Motilal Oswal Commodity Broker Pvt. Ltd., said by phone from Mumbai.

“The exodus from gold is expected to continue until next year probably if the global economy recovers and the equity markets do well,” he said. “Physical demand in India has already been low because in a falling market people tend to postpone their purchases.”

India is planning to offer inflation-protected bonds for the first time in 15 years next month to damp demand for gold and offer a hedge against inflation. That may not curb demand for jewelry, council’s Somasundaram said.

“The small and retail investors and those in the rural areas will continue to look at gold as a long term safe bet,” Somasundaram said. “As incomes increase, savings will increase and part of their savings will certainly go to gold. The investment demand graph will continue to climb higher.”

-BLOOMBERG