India’s plan to cut gold imports could backfire
INDIA is a developing country with hundreds of millions of its people struggling to survive on less than US$2 per day. Yet, it is estimated that households and temples in India privately hold between 18-25,000 tonnes of gold worth more than US$1 trillion which amounts to between 50 - 60 per cent of India's gross domestic product (GDP).
The government raised the import duty on gold from four to six per cent in January 2013 to rein in India's gold imports because it is concerned that high demand for the metal is fuelling the country’s deteriorating current account deficit.
If India fails to curb demand, it could have far reaching consequences.
India is a major gold consumer, so continued demand would push up the international price of gold further. This could fuel speculation in the commodity market, put pressure on currencies, raise the prospect of inflation and raise interest rates, which could affect consumer confidence and slow investment.
The rise in import duty is also a signal to domestic and international markets that India may not be able to tackle the fundamental challenges of fiscal deficit and inflation related to its economy.
If these fundamental economic issues are not tackled, the demand for gold could go underground, leading to an increase in smuggling, and fuel the practice of hawala, the informal method of transferring money abroad.
India’s gold production was estimated at a couple of tonnes in the 1980s, but more than 150 tonnes was reportedly smuggled into the country.
People seek safety in gold during an economic downturn. But, demand for gold in India symbolised status and security during the growth years of 2002-2008.
Annual gold imports to India have been between 800 and 900 tonnes over the past decade - more than any other country.
The row over soaring gold imports has focussed on the negative impact on the rising current account deficit (CAD).
The CAD reached US$38.7 billion, or 4.6 per cent of GDP, at the end of the first half of the current fiscal year (April-September 2012).
Finance Minister Palaniappan Chidambaram said in early January that if gold imports could be halved, the country’s foreign exchange reserves would surge by US$10.5 billion.
The Reserve Bank of India (RBI) agrees with the government.
The draft report of an RBI working group on gold and gold loans by non-banking finance companies (NBFCs) also favoured ‘a need to moderate the demand for gold imports’ using fiscal measures.
But higher duties on gold have already revived gold smuggling. Reports say that US$200 million worth of gold was seized between April and July 2012 from more than 200 cases of smuggling.
The man on the street regards gold as an excellent hedge against inflation. Gold gives good returns as an investment. In the last four decades, its value has risen about 200 times.
There are few other good avenues for investment, a fact acknowledged by government and the RBI.
They have underlined the need for more financial tools, including gold-backed instruments, such as e-gold and gold-backed Exchange Traded Funds (ETFs) that track the price of gold without undertaking physical movement of gold as a commodity.
Return on investment in gold in the domestic market between January 2008 and 2013, was 169 per cent, according to one estimate. The stock index averaged a return of between zero and slightly negative.
Gold has helped insulate large sections of the population from uncertainties caused by economic policy.
The affinity Indians have with gold will continue if the government is unable to rein in the fiscal deficit, restrain runaway inflation and stabilise the value of the rupee on a long-term basis.
Additional research by Ravi Kapoor and Nitu Maurya