Getting it wrong on gold

Updated: Oct 22 2013, 08:18am hrs
For 22 years India has been freely importing gold. Before that huge quantities sneaked in the country through smuggling. In 1991, the import of gold was officially authorised. Banks and public sector institutions welcomed these non-recognised importers as bullion dealers of creditable credentials. Now the same bullion dealers, with reversal of policy, again become suspect in the eyes of the officialdom which believes that investment in yellow metal is unproductive and, perhaps, anti-national. Unfortunately, bullion import is now wrongly targeted as non-remunerative investment while the poor performance of the economy can be attributed to lack of governance at the highest level.

With the crimping of gold imports, the government is only advertising its insufficiency or lack of means. After April 2013, the government hiked import duty on the yellow metal to 10%. An additional requirement, enforced with oversight of investigating agencies, is that 20% of the metal of any single import window has to be compulsorily exported before any further quantity can be officially brought in. These controls are apparently introduced to contain current account deficit (CAD) which was nearly 5% of the GDP. Ideally, CAD needs to be maintained below 3%.

With the above restrictions, the government claims that the CAD would be 3.7% or around $70 billion. At a current value of about $ 1350.00 per troy oz., Indian imports of 800 tons in a single year are valued at $34 billion about 1.9% of the GDP. Had imports been, as usual, duty free business, CAD would have been (3.7+1.9 =) 5.6%, which the finance ministry can ill-afford to project.

Indian demand for gold is inelastic which means the price, whether high or low, is immaterial to the demand/consumption of commodity. About 800 tonnes or more of gold whether priced $2000 per troy oz or $1000 per troy oz, will land in the country somehow. Since the 10% duty fosters an arbitrage through grey channels, more imports will be unofficial than official. So, the administrative steps may appear logical but curbing imports has initiated large-scale smuggling of gold. Therefore, national wealth will not be accounted correctly in the countrys balance sheet by the government despite it being fully aware of the shadow trade. Part of NRI remittances could fund gold imports through unreported transactions. To that extent official remittance will also decline.

The finance ministry can claim reduction in CAD to 3.7% on paper as of now, but it would be higher depending on the unofficial imports and diversion of remittances. Therefore, the projection of 3.7% CAD is a mere window dressing rather than the full picture. Ratings agencies will surely not ignore this adjustment by the government in its balance sheet.

Another paradox is that India was allowing duty-free import of gold even when the prices touched $2000 per troy oz but has restricted its imports when prices are 35-40% lower. Are we a unique country which always imports commodities expensively and debar them when they are available cheaper

There is a dichotomy of interest between the government and the nation. The agenda of the government is inconsistent with the general aspirations of the people. Unofficial gold will continue to be transacted both in rural and urban areas as has been the practice of the Indian society despite these inconveniences. Those who propagate that gold is a poor investment may be in error when most of the worlds central banks, including RBI, continue to access and hold gold as a valuable asset for contingencies and better long-term return.

Second, has it become the national agenda to convert a white economy of $34 billion into a grey one whether wholly or partially That can be inferred from decline in FY14Q1 import of $16.5 billion to $3.5 billion in FY14Q2 (about 80%) which means that a substantive import of metal has occurred through unreported inflows while increase in exports is only marginal, as the accompanying charts show. Therefore, exuberance over the reduction of CAD is flawed.

Emphasis on pushing export and tackling fiscal deficit, which could reduce CAD, is lacking. Food security subsidies, which are inappropriate at this point of time, should not have been introduced. Sugarcane pricing by the states of UP/Maharashtra and wheat values from FCI are bottlenecks in exports. Iron ore export, too, is in a limbo. Cotton exports are unreasonably regulated. We could have leveraged other Indian exports by allowing market premium on FX earnings for facilitating gold imports. That way, gold import could have been made FX neutral by almost 30-40%. Also, some of the non-essential defence imports can be pruned. Diesel/petrol subsidies need to be cut.

Comprehensively, the government has not acted prudently but has taken the easy way out of singling gold import as feeding CAD. There is a definite need to review the gag on gold imports.

The author is a commodities market analyst