Gold Duty Hike Will Not Stop People from Buying the Yellow Metal

January 7, 2013 at 09:01

truthing

Last week, the finance minister spoke out about the problem of gold imports. Some 12% of India’s import bill is on account of gold. With the current account deficit of the country worsening, the government’s thoughts are tending towards the huge drain that gold imports are on our forex reserves.

The minister said that had gold imports been half of what they were, the forex reserves would have been $10 billion higher. He indicated that measures to make gold import costlier – presumably, higher import duty – were in the works.

There was a range of reactions to his statement, with some saying that this approach was right, while others saying that it was wrong. Meanwhile, there were those who readied themselves for some market action on the expectation that if a duty hike looked imminent, then there would actually be a flood of pre-emptive demand, which would drive up prices as well as imports!

Perhaps the FM should not have shown his hand so early in the game. If he wants to hike duties, he should just go ahead and do it. In fact, by this logic, the best way to depress imports could be to hike duties and then say that they will be brought down at some point. This would create the expectation of an imminent fall in prices. Unfortunately, this would be just a one-time trick.

As for whether such a duty hike is desirable or not, the issue is a complicated one. From my perspective, which is that of personal finance and investment rather than one worrying about the country’s current account, it would be great if Indians move away from using gold as a means of savings. As a lot of people have been pointing out for long, gold is an unproductive asset.

Unlike stocks or bonds, it’s a type of asset whose value depends on nothing but a shared belief that its value will rise and keep rising. However, this apparently irrational gold boom has gone on long enough for it to shake the faith of a lot of people in the basic uselessness of gold.

Buying gold is practically hardwired into the Indian investment psyche and it will take a lot to shift that. A higher import duty will certainly not be enough. At best, a higher duty would help the government’s other deficit, the fiscal one, by bringing in some more revenue; provided the duty is not so high that imports shift to smuggling.

Is there any possible way in which the government could reduce the appetite for gold? Perhaps it could, but only by executing a full throwback to the 70s. It would have to impose very high customs duties or perhaps ban the import of gold altogether. Then, it would have to focus a great deal of effort on combating the inevitable smuggling operations that would start flourishing.

It would also be necessary to distinguish between gold that was legally owned before the ban from what was smuggled later. To do this, there would have to be some way of registering legal gold so that illegal gold can be chased down. Basically, this adds up to a reduction ad absurdum argument against the government being able to do anything to curb gold imports and consumption.

One of the cultural curiosities of gold consumption in India is that in many types of usages it is tied to a specific quantity of gold, rather than its value. The kind of family that would have bought 50 grams for a wedding a decade ago still aspires to the same quantity. While the government and economists are aghast at the increased value of gold imports, the increase in quantity is much less.

The only way a change will come is if there are other investment channels that become practical alternatives to gold. Even then, it will happen slowly and will only happen to a degree. In all the alarm about gold imports’ impact on the current account deficit, the decline in gold imports is not getting enough attention. Going by the trend so far, gold imports will probably be at least 30-35% less this year than the previous year. This is actually a huge decline. I wouldn’t bet on it yet, but a slow abating of gold fever may be on its way.