Tap the Bullion Market, don't Push it Underground

Open market, this is what the UPA Government has been seeking to promote. But the left hand knows not what the right does! And in one stroke, the Government has succeeded in giving boost to an industry that it was seeking to wipe out. Gold smuggling is yet again becoming the lucrative business that it was 20 years earlier!

It was in the Union Budget 2012-13 that the Government sought to check gold imports by doubling the customs duty of 2 per cent on standard gold. Earlier in January, the Government had imposed a 2 per cent. The Government argued that this was necessary as the sharp increase in gold imports was widening the current account deficit, it is an unproductive asset, prevents more productive savings  and it is a drain on foreign exchange. 

For people who see gold as an instrument of saving and not one of luxury, the Government's moves could not have come at a more difficult time: the stock market is one market they know little about and is not easily accessible, and economic and agriculture growth are yet regain their momentum. For most of India's working class, gold is an asset that is not merely a consumption good, but one that gave them financial security. In fact, it enabled them to channelise their savings in the absence other financial products, like even basic banking infrastructure.  More importantly, in times of high inflation, as was seen recently, gold is seen as the perfect hedge.

But interestingly, the four-fold hike in custom duty seems to be going against the very spirit with which the Gold Act was abolished in 1992, i.e., curtailing gold smuggling. If recent reports are any indication, gold seizures at domestic airports have risen by almost 10-fold in the months following import duty hike, indicating a rise in the grey market for gold. Even data from the Finance Ministry points out that between April and June this year, the customs authorities seized 200 cases of smuggled gold worth $169 million (Rs 9.4 billion), up by 272 per cent as compared to seizures of $46 million (Rs 2.4 billion) in the previous year.

Moreover, in the period when smuggling increased, data from the World Gold Council showed that India’s gold imports declined due to the impact of higher duties and rising prices. But, if one looks at the reported seizures by official agencies, it is unlikely that gold arrivals have declined. What this means is that the rise in illegal gold imports does not imply any slump in demand but only causes losses to the state exchequer.

More importantly, with the festive season round the corner, India’s rush for gold in likely to see some improvements despite the poor monsoons and the weak economy. Also, with the recent improvements in the rupee, gold is suddenly becoming attractive again.

Thus, in every sense, hike in duty is not resolving the problems that the Government aimed for; instead, it is encouraging the rise in illegal smuggling of gold, building up organised crime and moreover leading to heavy duty losses, both in terms of smuggled gold and concealing of black money. The solution instead lies in other policy measures be looked into from a different perspective. In this context, the Government could introduce some innovative gold-based products, such as gold bonds. Such bonds would enable the Government to monetise the vast stockpiles estimated to be worth $950 billlon being held by Indian households. Further, with prices now prevailing at a fairly high level, the new-found interest of Indians towards gold as an asset class (as against jewellery demand) and given the need for gold as a financial asset from both investors and economy’s point of view, its time to launch some gold-baseds product in the markets. Such a shift in the market preference for is evident, if one looks at the WGC’s figures for consumer demand for gold in 2011: consumer demand in value terms for 2011 rose by a robust 31 per cent for bars and coins in contrast to just 8 per cent for jewellery, a clear shift in the reason for which money was coming into gold. Such innovative products need to be encouraged in India by allowing market participants to structure and offer various combinations. Overall, the thrust should be on augmenting the array of financial products that appeal and are conveniently accessible by investors across both urban and rural areas.

As C Rangarajan, Chairman of the Prime Minister’s Economic Advisory Council, suggested in a report in February this year that the “best means of limiting the appetite for gold is to work towards making other kinds of assets more attractive….”

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