The shift from a specific duty to an ad valorem one on gold imports is something that was waiting to happen. The affinity for gold among Indians continues unabated, worsening in the process an adverse trade balance that has been a feature of the external sector of the country's economy. That perhaps explains the Government's decision to replace the existing flat customs duty of Rs 300 per 10 gram with a higher 2 per cent rate on the value of imports. But the modest nature of the response clearly highlights the policy dilemma confronting the Government. Any steep hike would be an invitation for the resumption of contraband trade in gold with its implications for terrorism and internal security. Equally, the additional impost – coming to roughly Rs 250/10 grams – is unlikely to quell the prodigious appetite for gold.
Indians poured some $50 billion (Rs 2.5 lakh crore) into gold imports during the year ended September 2011, a 46 per cent increase over 2009-10. This, even as their interest in other investment outlets dried up, with small savings schemes registering net outflows and retail mutual funds attracting a mere Rs 4,300 crore. What is more, gold demand has surged despite rising prices. An increasing portion of purchases are being routed through bars, coins and exchange traded funds, indicative of buyer perception of gold more as an investment than as a consumer good. But the problem is that gold, unlike most other saving avenues, is largely illiquid in its physical form. Buyers of gold jewellery, coins or bars cannot monetise their holdings without incurring costs in form of wastage and other charges. This tends to make gold investments a one-way street. Even loans against gold, a growing phenomenon, entail a low loan-to-value metric, besides stiff borrowing costs. As a result, capital ‘invested' in gold remains locked away as an unproductive asset for the economy. Moreover, as the country's gold requirements are almost entirely imported, they are a huge drain on foreign exchange. Precious metals, in fact, constituted 13 per cent of India's total import bill during April-December, making them next only to petroleum products. Given the unorganised nature of the gold market, a significant proportion of transactions also escape the tax net. Unlike most other investment transactions, gold purchases, till July 2011, did not even require furnishing one's Permanent Account Number (PAN). Even now it is mandatory only for purchases above Rs 5 lakh.
The challenge before the government is two-fold. One, it must somehow channelise India's gold hoard into the productive sectors of the economy. There is a case for launching afresh, the gold deposit schemes of the nineties, to incentivise households to deposit their gold holdings with select banks in return for a regular interest on the value of such deposits. The quantum thus impounded could be used to stave off fresh imports through some form of ‘repo' deals involving gold. The resultant liquidity in the hands of banks can then facilitate increased lending by them for productive purposes. Two, if Gold purchases have been made from income that has evaded tax, the Government must at least look for ways to increase its income tax collections. Making PAN cards compulsory for even smaller ticket bullion purchases could go some way in meeting this objective.