The Gold Import Rush Is Hurting CAD, But...
The gold story is never out of flavour in a country like India, where the obsession for the precious metal is second only to the game of cricket. What gold has managed to do this time is getting the finance ministry and Reserve Bank of India on the same page for the time being, and that is, both are in favour of making the precious metal costlier to check the current account deficit (CAD).
The New Year dawned with a very worried Finance Minister P Chidambaram telling the nation to moderate the demand of gold, saying, “I may add that we may be left with no choice but to make it a little more expensive to import gold.” The RBI working group also joined in saying that the fiscal measures to reduce gold imports might be revisited.
The government may raise the import duty on gold by two percentage points to 6% in the next fortnight as part of its plans to rein in the current account deficit (CAD), which is now at a record high. A widening CAD - the difference between export earnings and import expenses net of cash payments and remittances - is a worrying sign for a slowing economy where fulfilling immediate dollar payment obligations may necessitate dipping into the pool of foreign exchange reserves.
Is the situation that bad? If the statistics are to be believed, yes.
Gold imports grew 39% in financial year 2012 and accounted for almost three-fourths of current account deficit (CAD). India’s current account deficit was 4.2% of GDP, or $80 billion, in FY 2012.
“India imports about one-fourth of the total global supply of a little over 4,000 tonnes, and this excess gold demand is creating a stress on the system, particularly on the balance of payments,” said Subir Gokarn, Former Deputy Governor, Reserve Bank of India, at the Indian Banks’ Association’s annual Bankers Conference in Pune sometime ago.
The reasons for the huge imports are: Indians’ affinity for gold; the perception that the yellow metal provides a hedge against inflation; and the relatively high returns — in the last three years, investment in gold has given a whopping 70% return. “People cannot be denied an opportunity to invest in gold. Gold returns have been higher than those of the Nifty, one-year bank deposits and 10-year-government bonds over the last few years,” Gokarn said.
Is increasing import duty, the only solution to the situation?
“Increasing import duty on gold import is definitely not the only solution for reducing current account deficit. In fact, increasing import duty on gold may be counterproductive measure in the long run,” says Sudip Bandyopadhyay, MD & CEO, Destimoney Securities.
“Reduction of Import Bill and increasing the Exports is a priority. However, with 70% plus of the Import Bill being accounted for by oil import, there is a very little scope for adjustment, in imports. Global oil prices are not controllable and are determined by global market forces. The Sharp currency depreciation over the last couple of quarters, has added to the overall woes,” he says.
“In this environment, it is extremely important that exports are encouraged through multiple measures. Surging exports can surely help us in containing the current account deficit,” he adds.
Global uncertainties, surging inflation and non availability of other safe investment opportunities drive investors to buy gold. Traditionally Indians have always saved through gold, more than most other ethnic groups. Unless inflation is tackled, in a decisive manner, adhoc measures; like hiking import duty on gold, will meet with temporary success,” says Bandyopadhyay.
According to Kishor P. Ostwal, CMD, CNI Research, Gold Bonds are the only viable scheme before the Government. “They can issue gold bonds (tax free) against surrender of physical gold and use the gold so surrendered to borrow more at lower rates of interest in the international market. Amnesty could be still better form for conversion of black money into white. The lower rate means saving in interest cost and amnesty means a huge tax inflow and end to the era of black money,” he says.
Measures such as earning about $80-100 billion every year through the capital account (such as foreign direct investment) or meeting the deficit by depleting the foreign exchange reserves were also suggested, but experts clearly rule out both the options terming it unrealistic.
There is also fear of gold entering the country through illegal channels.”Increasing import duty on gold will only result in diversion of foreign exchange to illegal channels though illegal import of gold,” says Bandyopadhyay.
According to Bachhraj Bamalwa, Chairman, The Gem and Jewellery Trade Federation (GJF), the smuggling of gold was practically nil before the 2012-13, but has increased ever since the import duty has been increased.
“Gold worth Rs 942 crores was seized during a brief period of three months. A further increase in the import duty will encourage smuggling and the income generated from these activities might be used in various illegal activities, threatening national security as well it will destabilizing the overall economy of the country,” he says.
He further adds that despite a steep hike in the import duty, approximately 600 tonnes of gold was imported into the country during the 1st three quarters of 2012-2013 and the country’s trade gap has also not reduced and the governments foreign exchange reserve has also came down.
He also mentions that a ban must be imposed on banks selling gold coins. In most cases the banks forcibly sells gold coins to its high net worth clients and the gold keeps on lying idle with the consumers for years.
It is estimated that gold held by Indian household is 25,000 tonnes approximately, since generations.
“The government must try to bring out this gold and utilize it by lending it to jewelers at a nominal rate of interest. If the government can bring out 10% of this gold deposits by way of an amnesty scheme and the same is lent to jewelers as working capital, the country would not require to import gold for a minimum of three years which will help in minimizing the trade gap and as well as bringing the gold price down”, he suggests further.
The challenge, however, as Gokarn points out, is to find products which can give people gold-like qualities and, thereby, reduce the physical possession of the metal.
Measures such as earning about $80-100 billion every year through the capital account (such as foreign direct investment) or meeting the deficit by depleting the foreign exchange reserves were also suggested, but experts clearly rule out both the options terming it unrealistic.
There is also fear of gold entering the country through illegal channels.”Increasing import duty on gold will only result in diversion of foreign exchange to illegal channels though illegal import of gold,” says Bandyopadhyay.
According to Bachhraj Bamalwa, Chairman, The Gem and Jewellery Trade Federation (GJF), the smuggling of gold was practically nil before the 2012-13, but has increased ever since the import duty has been increased.
“Gold worth Rs 942 crores was seized during a brief period of three months. A further increase in the import duty will encourage smuggling and the income generated from these activities might be used in various illegal activities, threatening national security as well it will destabilizing the overall economy of the country,” he says.
He further adds that despite a steep hike in the import duty, approximately 600 tonnes of gold was imported into the country during the 1st three quarters of 2012-2013 and the country’s trade gap has also not reduced and the governments foreign exchange reserve has also came down.
He also mentions that a ban must be imposed on banks selling gold coins. In most cases the banks forcibly sells gold coins to its high net worth clients and the gold keeps on lying idle with the consumers for years.
It is estimated that gold held by Indian household is 25,000 tonnes approximately, since generations.
“The government must try to bring out this gold and utilize it by lending it to jewelers at a nominal rate of interest. If the government can bring out 10% of this gold deposits by way of an amnesty scheme and the same is lent to jewelers as working capital, the country would not require to import gold for a minimum of three years which will help in minimizing the trade gap and as well as bringing the gold price down”, he suggests further.
The challenge, however, as Gokarn points out, is to find products which can give people gold-like qualities and, thereby, reduce the physical possession of the metal.