Will import curbs on gold be effective? - Yes/No

Will import curbs on gold be effective? - Yes 

Lokeshwarri S. K.

The Government’s move to clamp down on gold imports will be effective, in the short term.

With the rupee threatening to move towards 58 against the dollar and the current account deficit (CAD) at record levels, the Reserve Bank of India (RBI) is taking the easiest route to tackle both, by clamping down on gold imports.

The central bank has announced a series of measures over the past month, including restraining lending against gold-backed assets, and restricting gold imports. The hike in gold import duty from 6 per cent to 8 per cent is the most recent announcement in this drive.

These moves will help bring down the frenzied increase in gold imports and help improve sentiment in the rupee. But the impact is likely to be short-term and the government and the Central Bank need to address structural issues to find lasting solution to the mounting CAD.

Empirical data shows that hike in gold import duty has resulted in drop in gold imports in subsequent months. For instance, the increase in duty from 1 to 2 per cent in January 2012, immediately followed by another hike from 2 to 4 per cent in March that year, resulted in monthly gold imports declining from $5,224 million in January 2012 to $1,835 million by June that year.

Similarly increase in gold import duty from 4 to 6 per cent this January resulted in import bill declining from $7,194 million in January to $3147 in March.

The current hike can, therefore, serve the government’s purpose of bringing down the import bill that is threatening to bloat due to the gold buying frenzy, witnessed in the aftermath of the sharp decline in gold prices in April.

If we look at the country’s trade balance, the deterioration is due to either external factors or structural issues. Services exports are hit due to the ongoing slowdown in the Euro Zone, while other exports need a long-term strategic plan to improve their competitiveness in global markets. Of the list of imports, the largest segment, that comprises crude and coal can not be clamped upon, nor can the domestic output be increased overnight.

The only area where the government has room for manoeuvre is gold imports.

Even though gold imports account for only 15 per cent of the country’s imports, doubling of the import bill in this commodity can have a disastrous impact on the CAD.

Not many would complain now about the RBI’s move since gold’s lure as an investment avenue has diminished slightly with the recent fall in prices. By launching inflation-indexed bonds, the RBI now need not have qualms about depriving investors of a hedging instrument against rising prices. 

Will import curbs on gold be effective? - No

Vidya Mahambare

As long as there are no other attractive investment options available, gold would remain in demand, no matter what steps are taken to make its purchases costlier. The spike in gold demand in May was due to three factors. First, a sharp drop in gold prices in April – nearly 12 per cent in just one week; second, the wedding season in May; and third, an advance announcement by the Reserve Bank of India(RBI) to impose restrictions on gold imports, giving a two week purchase window before the measures came into effect.

The pent-up demand for gold jewellery was released in May due to a sharp decline in gold prices. In volume terms, gold jewellery purchases had grown very marginally in the four years up to 2012 – about 2-3 per cent.

With the price rising from its April lows, the wedding season now over, the RBI’s import restriction in place, and the latest government step to raise customs duty on gold to 8 per cent, gold demand will naturally moderate in June.

These measures may reduce gold demand in the short run, but are unlikely to be successful over the medium term, unless the reasons for the attractiveness of gold are tackled. Rather, it might lead to an increase in gold trade via unofficial channels.

Why is gold so much in demand? Gold, even in the form of jewellery, is a highly lucrative investment and insurance product -- it is a liquid asset, unlike real estate.

It is an asset with relatively longer price cycles compared to the stock market. It is an insurance product that involves no paperwork to purchase or sell, unlike the load of papers and proofs that are needed to make a successful insurance claim. In recent years, it has also turned out to be a good investment product, offering real returns in a persistently high inflation environment without any competing financial products.

When the other investment options are not good enough, households prefer to invest in gold, whether in the form of jewellery or, increasingly, bars and coins.

Curbing gold demand via imposing import restrictions and hiking customs duty, therefore, could result in increased imports through illegal channels.

Therefore, the right policy response would, be to focus on improving other investment options – liquid, less volatile, easy to purchase and sell, with returns that keep pace at least with inflation.

A step in this direction was the RBI’s recent announcement relating to the introduction of the inflation-linked sovereign bonds that will be open for retail participation. But, there is a long way to go – right from developing corporate bond markets to reducing transaction costs in financial products.