Don't blame it all on gold: CAD crisis is self-created

By R Jagannathan

Everyone likes to blame gold for the country’s yawning current account deficit (CAD), which could top 4.5 percent of GDP in 2011-12 at around $85-90 billion.

The argument goes thus: if we leave gold out of the equation, the CAD is not so alarming. The latest to emphasise this is C Rangarajan, Chairman of the Prime Minister’s Economic Advisory Council (PMEAC). He said: “If you look at the constituents of the CAD and if you exclude gold, then it becomes clear that this (high import of gold) is what has caused it. Gold was treated as a hedge against inflation. So efforts are required to contain inflation at 6-6.5 percent.”

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While he may be right about people importing gold as a hedge against inflation, it does not mean that gold caused the CAD crisis, which is one factor that led to India’s rating downgrade by Standard & Poor’s. Gold import is a symptom of the country’s economic malaise, not the disease itself.

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A month ago, Saumitra Chaudhuri, Planning Commission member, made the same point about CAD in the previous year (2010-11): He wrote in The Economic Times: “The CAD in India has a large idiosyncratic element - that is the huge import of gold. Our CAD in 2010-11 amounted to $44 billion, while the value of import of bullion (mostly gold) was $42 billion, up from $30 billion in 2009-10.”

The numbers, however, do not really support the idea of singling out gold and bullion as the villains in the CAD crisis.

Let’s start with last year (2010-11), when gold import was roughly equal to the value of the CAD ($42 billion against CAD of $44 billion). But should we take the whole amount, when some of it could have been used for the export of gold-based items and jewellery? Moreover, the incremental amount of import over the previous year was $12 billion. So only $12 billion out of the CAD of $44 billion in 2010-11 was due to gold - around a fourth of the gap.

This year, when the CAD could be around $85-90 billio n, the increase in gold import is about $19 billion. This is less than a fourth of the projected CAD. A lower proportion than the year before. The total gold and precious metals import of $61 billion is also far below the expected CAD.

Sure, gold imports are a noticeable factor in worsening the CAD, but they aren’t the cause of it.

On the other hand, look at what gold does for us. In 1991, when the country was up the creek without a paddle, we had to pawn our gold. If we ever get into a scrape on the external front, the government can seek the citizen’s gold against bonds and use it for external collateral.

And remember, in 2009-10, the Reserve Bank itself imported 200 tonnes of gold to add to its reserves. And this gold has gained more than Rs 1,00,000 crore in value - strengthening the country’s balance-sheet when the external situation is in turmoil.

What the ordinary citizen is doing is taking a similar flight to safety - primarily for his or her own benefit, but gold that stays in the country is accessible to the government for a price. It is a useful buffer to have. If the CAD gets any worse, this gold hoard could be apart of the solution.

In any event, the surge in gold imports can be controlled by higher taxes. But what about the surge in the other major imports, the real causes of the CAD crisis? They are all the results of policy paralysis or policy disasters.

Consider:

Petroleum imports surged by 46.9 percent to $155.6 billion in 2011-12: This is the result of ruinous energy subsidies in India.

Coal imports have surged by 80 percent to $17.6 billion: This is the result of Coal India’s inability to open new mines due to green issues, apart from internal inefficiencies.

There has been a surge in fertiliser imports by 59 percent to $11 billion: This is the result of unbalanced urea subsidies.

The gold import surge is the symptom of an unreformed fisc and untamed inflation. It is not the cause of the CAD disease. That problem was self-created.