India’s Current Account Deficit Paradox – Curbing Gold Import ?

Gold accounts for one half of India’s current account deficit, so the authorities want to reduce the imports by raising import duties. The question is whether or not this will increase the public’s desire to partake of the forbidden fruit. It is interesting that the Financial Times’  headline writers chose to describe the desire of Indians to hold their capital in the form of gold as an “unhealthy addiction.” It certainly is unhealthy for those who wish to manipulate the value of money.
 
India does not have many gold mines and majority of its consumption is through imports. No doubt this has put a huge stress on the economy. Presently, the rising value of the dollar is adding to the woes. Sophisticated investors have opted for exchange-traded funds, or ETFs, rather than physical metal, leading to a 300 per cent rise in assets under management by gold ETFs since September 2010. In terms of quantity, imports may drop to 800 tonnes this fiscal year. However, rising prices, both of the metal and of the dollar, will ensure that this will still exert substantial pressure on the balance of payments.

A rise in import duties is only one of the ideas under consideration, and it was no surprise that a deliberate threat at the start of this year by Palaniappan Chidambaram, Indian finance minister, to make gold “a little more expensive to import” sent shudders through the international gold market.
 
India is the world’s largest gold importer and accounts for more than a fifth of global demand. Last year, a drop in imports of about 20-25 per cent – perhaps caused by a previous increase in import duty but also the result of the slowdown of the domestic economy – was one of the main factors in gold’s relatively lackluster performance.
 
The focus on the cost of India’s gold imports at an official level could be seen as a threat to what is the largest physical bullion market alongside China. What is not yet clear is whether the measures contemplated by the Indian authorities will actually curb the volume of gold imports, and so affect the price further.
 
Mr Chidambaram and other officials are concerned about the apparently unstoppable urge among the country’s 1.2bn people to buy gold jewellery and invest in bullion. There are two main reasons for this: the swelling current account deficit and the risks posed to the stability of the banking system.
 
India’s current account deficit hit a worrying 5.4 per cent of gross domestic product in the three months to September, and in some months gold imports accounted for half the gap. The “impact of huge gold imports on external stability” was described this month as “a major concern” by a Reserve Bank of India working group set up to study the issue of gold.
 
In its draft report, the RBI also spoke of “systemic concerns” arising from the “huge borrowings” of a growing number of so-called non-banking financial companies that lend money to Indian retail clients, storing their gold and gold jewellery as collateral.
 
One option for Mr Chidambaram, analysts say, is to increase the import duty from 4 per cent to, say, 6 per cent in an attempt to stifle demand. The revenue raised would have the beneficial side-effect of helping to trim the fiscal deficit. Higher tax, on the other hand, could simply divert more of the gold trade on to the black market.
 
In any case, only about 10-15 per cent of Indian consumers are price-sensitive when it comes to gold. “It’s part of our tradition and we keep on buying gold,” J Karne at Anand Rathi says. “It’s our compulsion. We can’t do anything about it.” The stock of the precious metal in India is estimated at between 12,000 and 25,000 tonnes, and greater prosperity in rural areas is pushing demand ever higher.
 
Another approach, championed by Raghuram Rajan, the government’s chief economic adviser, is to focus not on the desire for jewellery but on gold’s weaknesses as an investment. That means promoting non-gold financial investments that produce real returns for citizens, although the strategy has been undermined by gold’s strong performance in rupee terms as the rupee has fallen against the dollar.
 
Last but not least – and this would cut India’s external demand for gold while meeting domestic demand – the central bank and the government want to make better use of India’s vast existing gold stocks. Ideas under consideration include various gold-backed financial products not requiring gold from abroad, such as an exchange-traded fund backed by central bank gold and a scheme under which public sector banks could lend on the physical gold they hold as collateral for loans.
 
[sociallocker]
Philip Klapwijk, of Thomson Reuters GFMS, a leading precious metals consultancy, says: “India is quite concerned at the impact of gold imports on the balance of payments and that such a high proportion of savings is ‘sterilised’ by being in gold form instead of being put to productive use.” In the end, however, it may be market forces – and not Mr Chidambaram’s suggested tax increases or any official scheme to recycle hundreds of tonnes of India’s idle gold – that succeed in suppressing demand for gold imports.
 
With some currency traders forecasting a rise in the rupee this year, and some commodity analysts seeing the end of gold’s international bull run, gold is likely to be a less attractive investment than it was. Indian consumers, however, have a history of ignoring attempts to wean them off their addiction. Even a 6 per cent premium over the international price is not going to reduce Indians’ basic desire to hoard the metal and it is expected Indian jewellery demand to rise “decently” from last year’s poor showing.
 
The Indian affinity with gold runs deep , noting that previous efforts to reduce demand, for example in 1962-68 when the government introduced restrictions on gold trading and ownership, merely resulted in an increase in smuggling. Habits and attitudes towards gold do not change quickly.
 
Fundamentally today, gold is not being used by consumers for its true purpose but rather is being seen as an instrument to hedge inflation or as a safer security option in which their income can be invested upon. Due to this fundamental problem, the prices of gold, though determined by the market forces, is not truly reflective of its intrinsic value. Reforms have to be brought in not just to stabilize the prices of gold or to curb the import bill or current account deficit, but rather to change this fundamental attitude of the common man and to show gold its true place in the international market and thereby to the Indian household. This can be solely done by bringing the so called dead assets or rather the value of the dead assets in the mainstream economy. In the course of the implementation of such reforms, the value of the yellow metal is bound to correct and the import bill would decline.
 
Hence merely curbing gold imports by imposing excise duty will not work as inflation continues to persist in India. Hence a better way would be bring into use the vast reserves of gold using financially engineered products as inflation indexed bonds.
 
[The article has been written by Gaurav Prakash Mashalkar. He is an MBA from 2013 Batch of Jamnalal Bajaj Institute of Management Studies (JBIMS), Mumbai ]
[/sociallocker]

You will love reading: India’s E-commerce.  Must read article The new boss

What's your opinion ?

Loading Facebook Comments ...
0 Comments

Leave a reply

Contact Us

Send us an email and we'll get back to you, asap.

Sending

©2017 IdeasMakeMarket.com India's Finest Management Portal. IdeasMakeMarket and its logo are registered trademarks.

India’s Current Account Deficit Paradox – Curbing Gold Import ?

by Ideasmakemarket.com time to read: 6 min
0

Log in with your credentials

Forgot your details?