How does this affect the external gold market? The answer so far is very little. The market in China is constantly growing and China's gold demand may overtake India as the largest consumer in the near future. Physical demand for gold coins has been strong globally. But India's traditionally strong period of festival and wedding demand now running to Diwali in November will likely see much lower gold imports through official channels.
Of course, gold will still flow where it is needed. The controls that the Indian government has established have done little to stay the hands of investors.
It's almost too simple to believe that the government cannot recognize where their focus should be. India's gross domestic product growth rate has been on decline since 2011 from a high of 9.3% to currently 4.4%. Capital outflows, distrust of government regulations, and the inability to get businesses active in India are the primary causes of this government's troubles. If the business environment were to be improved then the economy would grow as well. The people themselves would reinvest into their country.
In the current environment, in which industry is stifled and unable to grow within India, then we can expect to see, sadly, a decline in confidence and GDP. Continuing down this path will inevitably lead to another economic disaster such as Argentina is suffering, along with many other countries with closed markets.
In a country like India, where they must import their energy alongside their gold, it may appear difficult to keep their balance of payments in the black. Yet their human capital is strong enough at this juncture to supersede this difficulty, if only the business environment were improved so that companies such as Cipla would not move out and instead expand their operations. Foreign investment also looks unlikely to reverse without a change of policy. Goldman Sachs downgraded India to underweight and recommended investors stay selective in that market.
It is better to have a reasonable import tax, and let business work, so the government can earn income from it rather than attempting to stop the flow of gold via exorbitant duties and currency controls. Blocking the free inflow of gold is a bad symptom of India's economic problems. It can't be a cure.