Gold illogic

In his landmark 1992-93 Budget, Finance Minister Manmohan Singh dealt a body blow to gold smuggling by permitting Indians returning from abroad to bring in 5 kg of the yellow metal and making the rupee partially convertible. With the rupee allowed to float freely and gold imports further liberalised, with Customs duty lowered to just Rs 220 per 10 gm, the hawala premium for dollars and their diversion to smuggle the yellow metal ceased. Therefore, it is ironic that Manmohan Singh, who may deliver his last Independence Day address as Prime Minister today, is presiding over the complete reversal of a policy he initiated. Tuesday’s decision to raise the gold Customs duty to 10 per cent would effectively mean that importers will pay about Rs 2,650 per 10 gm. Compare this with the Rs 300 specific duty they shelled out only in January 2012!

The latest duty hike could well be the tipping point for smuggling to make a return. A difference of Rs 2.65 lakh on just one kg of gold is surely temptation enough for duty evasion and the trade to go underground — something that also has implications for internal security. The four-fold increase in gold seizure cases so far this year suggests this is already happening. Also, whenever a rise in gold prices is accompanied by duty hikes, the yellow metal only becomes more attractive to people as a store of value. The worst case scenario is one where import curbs — including the measure stipulating that importing agencies set aside at least a fifth of the bullion they bring in for re-export — lead to artificial domestic scarcity and push up prices. These will only give a further boost to the underground trade and the desire to hold savings in gold.

As before, the Government is making the mistake of trying to curb demand for gold by addressing the symptom, not the cause. If despite all the recent duty increases, India’s physical gold imports have gone up by 87 per cent during April-July, it is mainly a reflection of the public’s loss of faith in bank deposits and other financial savings avenues. That loss of faith, in turn, is a result of the Government not doing enough to control inflation. In tackling the symptom (demand for gold) instead of the underlying cause (inflation), the Government is administering the wrong medicine (duty hikes) that has bad side-effects (smuggling). The surprising thing is that both Manmohan Singh and the current Finance Minister are fully aware of this. While the former delivered the first blow to gold smugglers, it was the latter, as Finance Minister in October 1997, who dug their grave by permitting a host of banks to freely import gold by paying a nominal duty without any re-export obligations.