Ideally there should be no curbs on imports of any commodity especially when we are committed to a free market system. Imposing any restriction on imports of any commodity opens up the opportunity for the creation of a grey market which goes beyond the legal processes. Based on this line of reasoning the import of gold should not be ideally curtailed.
However, we do have broader issues to address here. In FY14, the balance of payments came under pressure when the import bill went up sharply due to higher import of gold. This was exacerbated by the Fed tapering news which forced the government and RBI to impose controls. The situation did ease and we were able to rein in the current account deficit at less than 2% of GDP in FY14.
To get an idea of how serious the problem could be, the ratio of gold imports in total imports could be tracked. It increased from 6.4% in FY10 to 14.5% in FY13 before coming down to 10% in FY14. In value terms, it had peaked in FY13 at $56.5 billion followed closely at $53.8 billion in FY13.
In order to control the import of gold in FY14, the government and RBI followed a multi-pronged policy. First, the duty rate was increased to 10 percent and second, a 80-20 rule being imposed whereby all importers had to satisfy an export obligation to be eligible for imports. Further there were restrictions on the entities that could import gold.
The story of gold is peculiar in India. We are the second largest importer and consumer of gold in the world with a share of around 20 percent after China. It is believed that this year it could get higher. And here we are talking of the official market only.
There are two major consumers of gold: households and investors. The typical domestic household holds gold for security and prestige purposes. This holds especially in the lower income households where it is a part of tradition, and the people do not let go of the metal any which way.
If the price is high they buy less as they typically allot a certain sum of money for such purchases, which is normally in jewellery form. Therefore, the schemes mooted earlier such as gold deposits just don't work with this class.
The second category is the investor who sees gold as a very good investment as the price of gold is always expected to increase over the medium term. Typically, in a span of five years we can expect returns of between 15-20 percent per annum and the advantage is that such transactions can be done without any tracking. One does not need to satisfy any KYC when buying gold. For this market segment the choice of entry and exit is based on the market price and the conjectures of the entity on the same.
The options open to the government and RBI to control gold imports are two-fold. First, the duty can be increased further to make it expensive, and second, we can have further curbs on the import as this can reduce demand for holding gold. The negative fallout is that people will buy in black as given the size; it can be easily transacted as it is not bulky.
The first option is more effective. By increasing the price, those who have a fixed budget will necessarily buy less gold as their purchasing power comes down. Investors will see less of a future gain when the price is high and could be less enthusiastic.
However, the problem is that international price of gold has come down to less than $1,200 an ounce and given that one could expect the price to cross $1,500 once the world economy reaches equilibrium, it would be an attractive purchase today notwithstanding the higher duty. This class becomes important as it also includes ETFs which will find it worthwhile to build their stocks of gold now.
One way out is to migrate such investors to the derivative market where exchanges like NCDEX offers various contracts - ranging from small to big contracts. This way the investor demand can be moved away. For this, we need to have longer contracts and probably offer some tax incentive like the waiver of CTT to ensure that this market remains attractive for the investor.
On quantitative measures, there can be further constraints put on importers by increasing the export component to 30 percent from 20 percent. The Sebi could ensure that there are no new schemes permitted in gold ETFs and there can be a ban on buying gold coins.
The last will deter people from investing as coins are a neat way of buying and selling without any conversion costs. By allowing only gold jewellery to be purchased, this option can be stymied. But as mentioned earlier, this will increase the level of smuggling as people can bring in gold coins from outside which will be a logistical challenge at the airports.
The US Fed is bound to increase rates sometime in 2015 which can have an impact on our capital flows, though one can never be certain. The present cooling of oil prices is not considered by market players as being only transient and the general bets are still around $100/ barrel. This being the case, any recovery in the Indian economy will push up the non-oil bill too thus aggrandising our current account deficit.
The rupee which is stable now could hence come under pressure. It is, therefore, timely that the government and RBI are looking closely at this phenomenon of rising gold imports. With the marriage season starting and the global price reining low, imports are bound to increase.
Rather than be caught on the back foot, it does make sense to tackle this issue through multiple measures to ensure that the external count remains stable. Therefore, any measure to control the flow of gold imports should be welcomed.
The author is chief economist, CARE Ratings. Views are personal
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Updated Date: Nov 20, 2014 10:20:53 IST