Dear FM, make other assets more attractive before curbing gold imports

If you think the Finance Minister was harsh on gold in the Union Budget, here's some more bad news for you.

Media reports suggest harsher steps may be on the way. "If the CAD (current account deficit) crosses 3.5 percent (of GDP) we will have to think of cutting down some imports," Finance Secretary RS Gujaral said in Delhi on Monday, according to The Economic Times. Read 'gold' in place of 'some imports'.

India's gold imports are estimated to hit a whopping $58 billion in the financial year ending March 2012, much higher than the $30-$33 billion of imports in previous years, according to a report by the Prime Minister's Economic Advisory Council (EAC). Along with silver imports, they account for the country's biggest import expenditure after crude oil.

In an attempt to curb the gold lust, in his Union Budget speech on 16 March, Pranab Mukherjee doubled the import duty on gold bars and coins to 4 percent, as well as the excise duty on refined gold to 3 percent. A 1 percent excise duty on non-branded gold jewellery was also announced. Jewellery purchases in excess of Rs 2 lakh would also attract a 1 percent tax from 1 July, he said.

It was the government's second attempt to lower gold demand: in January, it trebled the import duty on gold by changing the basis of duty as a percentage of value from weight.

 Dear FM, make other assets more attractive before curbing gold imports

ReutersThe new measures upset everyone from gold traders to consumers. Gold traders went on strike for three days starting Saturday to protest the imposition of the higher import duty. Reuters

The new measures upset everyone from gold traders to consumers. Gold traders went on strike for three days starting Saturday to protest the imposition of the higher import duty. On Monday, they decided to extend the strike, which comes in the middle of the wedding season, for two more days (until 21 March).

Prithviraj Kothari, president of the Bombay Bullion Association, predicted that India might import 35 percent less gold in 2012 because of the tax changes, according to a Bloomberg report.

For the government, that's the whole idea. India imports around 900 tonnes of the yellow metal annually. Higher gold imports require the country to spend more foreign currency to pay for those imports, which increases the total import bill and widens the current account deficit (the difference between exports and imports after taking into account foreign remittances and payments).

The government is hoping its measures will push households to invest in financial assets such as stock and bonds instead of 'non-productive' assets such as gold.

Of course, it would have helped if the Finance Minister had outlined a plan for economic growth in the Budget to inspire confidence in the prospects of financial assets instead of merely trying to curb gold imports. Given that the economic outlook remains murky (the economy is struggling to grow above 7 percent, while corporate margins remain under pressure) and the threat of inflation surging again remains high, it's hard to argue against investing in non-financial assets such as gold.

Even the EAC report notes that the best way of limiting appetite for gold is to make financial assets more attractive."The first part of this task is to improve domestic growth and investment conditions - a function of overall macroeconomic stability. The second part will be to make investment in life insurance and mutual fund schemes at least as attractive, as was the case till March 2010, where the data show net inflows were sizeable and sustained," the report says.

Yes, get those done before clamping down on gold, whose prices have rallied for 11 straight years.

To be sure, the government's attempt to dampen demand in the world's largest bullion market is expected to push global prices lower in the medium term, along with a host of other factors. A Forbes blog post suggests that gold prices could slide all the way to $1,500 per ounce in the next 12 months. Will that make Indians buy even more, despite the curbs? Or push up gold smuggling?

We'll have to wait and see.

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Updated Date: Dec 20, 2014 09:11:33 IST