Indian gold refiners just months ago were ramping up capacity and struggling to secure enough ore from miners. Now, they are suspending operations as a surge in smuggled bullion wipes out wafer thin margins.

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Gold importing banks and big jewellers have also been hit by the growing entry of illicit gold, which avoids import duties and makes its way on to the so-called "grey market" where it is sold to end-users at a discount.

Smuggled gold could account for more than a third of demand this year in India - the world's second-biggest buyer of the metal after China - potentially costing the government over $1 billion in lost revenue.

The upsurge will lead to pressure for a reduction in the 10% import duty and a rethink on recently introduced levies on gold jewellery, which critics say are boosting the unofficial trade the government has been trying to curb.

"Gold refiners have less than a 1% margin. If smugglers offer 4% or 5% discounts, then we have no choice but to close our operations," James Jose, secretary of the Association of Gold Refineries and Mints told Reuters.

All 32 refineries in the country have stopped buying dore - a semi-pure alloy made by miners - in the past few months and are relying on treating scrap gold until market conditions normalise, he said.

"Last fiscal year we refined 120 tonnes of gold. With local scrap supplies we can produce 20 tonnes of refined gold in the current year," said Rajesh Khosla, managing director of MMTC-PAMP India, the country's biggest refinery.

Smuggling Grows

India raised the duty on gold imports to 10% three years ago, aiming to dampen buying and narrow the current account deficit (CAD) in a country where gold is seen as a store of wealth for rich and poor alike.

Smugglers evade the duty and offer cheap gold to buyers such as bullion dealers and small jewellers, who can pay up to $100 an ounce below official domestic prices, currently around $1,340 an ounce.

Falling gold prices deterred the illicit trade last year but smuggling has surged in recent months amid rising prices and the reintroduction in March of a 1% local sales tax on gold jewellery.

Smuggled gold into India could double to as much as 300 tonnes in 2016, said Bachhraj Bamalwa, director at All India Gems and Jewellery Trade Federation, although the World Gold Council (WGC) has put the figure at 160 tonnes. At 300 tonnes, the government would forego about $1.3 billion at current gold prices.

The new sales tax has encouraged smaller jewellers in particular to buy on the grey market, said Somasundaram PR, managing director of the WGCs' Indian operations. The jewellery must be sold without receipts, but goes to customers looking to hide funds from the authorities.

The Finance Ministry did not respond to requests for comment on gold smuggling.

Banks Hit 

The legal trade is also facing headwinds from a 26% rise in the gold price this year which has discouraged overall buying and made smuggled gold available at deep discounts.

India's official gold imports fell 57% in the first seven months of 2016 to 215 tonnes, and could fall more than 60% for the year to 350 tonnes to 400 tonnes, the lowest level in two decades, said Sunil Kashyap, managing director, Global Banking and Markets at Scotiabank. 

Banks, which until last year were the main source of gold supply, are losing their market share quickly.

"Since there were hefty discounts in the grey market, consumers shifted from banks to grey markets," Arindam Sarkar, senior vice president at Axis Bank, the biggest bullion importing bank in the country, told Reuters.

"So far in 2016 our bullion business is down nearly 75%," he said.

Bigger, more reputable jewellers are also suffering.

"Small jewellers buy gold at 4% or 5% discount and then sell jewellery at 1% or 2% discount," said Aditya Pethe, a director at Waman Hari Pethe Jewellers in Mumbai.

"The business of big jewellers like us is getting affected. But jewellers buying from the grey market say they have little choice. "I wasn't buying gold from grey market for months, but others were buying and doing business," said a Mumbai-based jeweller, who declined to be identified.

"In the last two months, I have also started buying as I have to survive. I have to pay employees."