Is curb on gold import enough to reduce CAD?

Within a fortnight of his promising to take steps to control the rising gold imports inflicting tremendous pressure on India’s widening current account deficit, Finance Minister P Chidambaram has delivered by increasing customs duty on gold by 50 per cent.

This implies that the landed cost of gold in India has gone up sharply as the country is a net importer of the yellow metal. But a concern arises as to whether this duty hike will help the government achieve its objective of curbing gold imports given the penchant Indians have for gold.

India is the world’s largest importer of gold and consumes close to 800 tonnes every year. Of this, close to 600 tonnes goes into making jewellery which translates into consumption demand with the rest for other investment requirements. Industrial use of gold is a meagre one to two per cent.

The government wants to discourage gold buying as the precious metal is the biggest contributor to the import bill after crude oil. It is of the view that increasing import duty can curb India’s whopping demand for gold, and the consequent massive outgo of foreign exchange. Gold imports have already reached $38 billion till December 2012. Imports were of the order of $58 billion in the entire last fiscal. Hence, a duty hike from 4 per cent to 6 per cent.

Market watchers and gold dealers do not subscribe to the view that import duty hikes will help. They say any amount of tax hikes will only have a short-term effect on the demand for gold in India.

“Gold is the most attractive asset and a savings instrument which fetches more than 30 per cent returns annually,” said All-India Sarafa Association Vice-President S K Jain.

Jain also said that in the past year, gold demand has not fallen even after the increase in import duty earlier. Only the form of investment has changed. “Earlier, people used to invest in gold jewellery, now they invest in gold bars,” he said.
In last year's budget, when the government doubled import duty on gold from 2 per cent to 4, gold import volumes contracted by around 25 per cent year-on-year during the first three quarters of 2012.

The additional imposition of import duty now is also seen as moderating gold imports to only 750-800 million tonnes this year.

Moreover, a fortnight-long gap between the announcement of the government’s intent to make gold more expensive and its actual implementation triggered a massive jump in gold imports, which traders estimate at about 40-50 tonnes in the first week of January.

Besides, import restrictions on gold are also expected to give rise to its shipment through unofficial channels. Although it is difficult to determine how much imported gold has been smuggled into India after the rise in import duty twice in the same fiscal, dealers say the amount is quite significant.

The government says it has tools to check the smuggling of gold, but past experience proves that a duty jack-up always leads to more smuggling of gold and resultant rise in black money.

Another reason, why unduly high restrictions on gold imports is not called for, is that India is also an exporter of gold jewellery. Gold imports in India are also directly linked to exports of gold jewellery, which may be affected when clamps are placed on imports.

In India, where gold is considered a good hedge against inflation, the higher duty may make it more expensive, but it may also reinforce the belief among consumers that gold prices will always rise, which will lead to them indulging in more purchases.
Analysts say the way out is to make savings instruments more attractive in order to discourage people from investing in gold. Experts also feel that the time has come to make equity and debt instruments more attractive.

The government has proposed to make changes in the gold deposit scheme and make it more attractive for people to deposit their idle gold with banks. The proposed linking of Gold Exchange Traded Funds (ETF) with gold deposit schemes is expected to help in terms of decreasing imports and ensuring that gold is monetised in the country.

An estimated 20,000 tonnes of gold are lying idle with Indian households, which can be channelised into constructive use. The measure will also help the government to get a firm handle on the rising current account deficit, hitherto aggravated by gold imports. Although it is difficult to establish the impact of the hike in excise tax on the CAD and by how much it will come down, there will be some moderation, according to Economic Affairs Secretary Arvind Mayaram.

India’s CAD widened $38.7 billion or 4.6 per cent of the GDP in the first half of the current financial year. Though the current flow of foreign capital is sufficient to finance the deficit, it is not seen as wise to pin too much hope on external flows to finance India’s CAD; hence, the government needs to curb this deficit.

Capital flows have not dried up. But there is always the fear that if the economic recovery in the US and Europe do not take place as expected, capital would not flow into emerging countries like India easily and that may put pressure on the balance of payments situation.

“Gold imports are a huge drain,” said Chidambaram. It is true that India’s current account would be in surplus mode if gold imports are excluded. But, the experts say  that the government needs to treat the cause rather than the symptoms. In India, purchase of gold is more linked to savings than consumption. Therefore, the need to have saving instruments that give golden returns.

India also needs to fix sluggish exports and the relentless increase in oil imports to service CAD.