MoF considering shifting part of gold imports from current to capital account

Written by Sunny Verma | New Delhi | Updated: Feb 14 2012, 12:12pm hrs
The finance ministry is examining a proposal to take investment-type gold imports out of the current account and instead, treat them as part of the capital account.

Kaushik Basu, chief economic adviser to the finance ministry, is studying this proposal, which could help reduce the country's current account deficit (CAD) which is expected to be over 3.5% this fiscal, the worst in recent years. Policymakers have little choice other than financing the current account with the capital flows that could be not only be unsteady but also uncertain.

Shifting a part of gold imports from the current to the capital account is a zero-sum game and there are economists, including those in the government like principal adviser in the Planning Commission Pronab Sen who feel this is a flawed method.

There is a suggestion from some economists that since a large portion of gold is imported for the purpose of investments, it should not be treated as part of consumption goods in the current account of balance of payments (BoP), a senior official said on condition of anonymity. The Economic Survey 2011-12, to be tabled in Parliament on March 15, could reflect a view on the subject, he said. The argument is for treating the investment portion of the gold as a capital account entry in the BoP. We are working on both gold imports and its implications on the CAD as part of the Economic Survey, the official said.

CAD, the difference between export and imports, plus remittances and net invisible, is financed through surplus in the capital account. Capital account includes foreign direct investment, portfolio investment, banking capital and external loans.

Incremental gold imports are expected to add close to 1% of GDP to the CAD in 2011-12. CAD stood at 2.6% of GDP in 2010-11. The RBI and finance ministry are comfortable with a CAD of around 2.5% of the GDP.

Conventionally, excluding trade in gold between central banks, any trade in gold is captured in the current account. Monetary gold or the gold held by central bank is already included in the capital account as a financial asset with no corresponding liability. Three countries UK, Japan and Switzerland are the only exceptions to the practice of treating non-monetary gold import as a capital account entry.

Indranil Pan, chief economist, Kotak Mahindra Bank, said the debate regarding treatment of non-monetary gold in the BoP is worthwhile, but it would ultimately have zero impact.

While taking it out of the current account would help lower CAD, it would simultaneously lower the net surplus on the capital account, Pan said.

Sen, however, said the idea is fundamentally flawed. In the BoP, the distinction between current and the capital accounts has nothing to do with consumption or investments. What the capital account tells us is whether any transaction results in creation of liabilities or assets for a country vis-a-vis the foreigners, he said. Basically, the capital account of BoP measures how much liabilities a country is building up vis-a-vis the rest of the world. Whether you are converting it into a productive asset or not is not the question, Sen added.

For instance, an NRI depositing money into an NRI account in India creates a liability on the country, and therefore is captured in the capital account. But if the NRI sends money to his relative, then it is not a liability; but it is counted as remittances in the invisibles head in the current account.

Expert groups of the International Monetary Fund have debated this subject in the past. Apparently, the reason why UK, Switzerland and Japan treat non-monetary gold is because of massive trading including overseas that happens on this underlying asset.

Since much of gold these countries keep in their vaults or lockers support the trading done by foreigners on this underlying, it results in creation of liabilities vis-a-vis the foreigners.

India's gold imports are estimated at $50 billion in 2011, up from $38 billion in 2010, with jewellery accounting for around 65% of the country's gold demand.