Is increasing import duty on gold a good move? - YES

Given the current growth scenario and the likely capital flows, a sustainable capital account deficit is considered to be no more than 2.5-3 per cent of GDP. However, the CAD reached a 30-year high of 4.2 per cent for 2011-12.

Though the CAD somewhat moderated to 3.9 per cent in the first quarter of 2012-13, it has shot up sharply to 5.4 per cent in the second quarter. Gold contributed nearly 30 per cent of trade deficit during 2009-10 to 2011-12, which is significantly higher than 20 per cent during 2006-07 to 2008-09. The purpose of the hike in import duty is to discourage import of gold. This was a necessary step.

The higher imports of gold could have been justified in the macro context, had gold re-exports, as a percentage of gold imports, been rising. However, this has declined from around 41 per cent to 29 per cent from 2008-09 to 2011-12, suggesting that a higher percentage of imported gold is now domestically used, putting pressure on the forex reserves as well as the exchange rate. The hike in import duty apart from discouraging imports will contribute additional revenue to the government and help contain the fiscal deficit.

However, recently, the attractiveness of gold is also on account of its high return

vis-a-vis bank deposits in a high inflation environment. This has led to a shift away from financial savings, and is not desirable in a developing economy. Compared to WPI growth of 6.5 per cent per annum between 2006-07 and 2010-11, gold prices were up by 23.7 per cent.

In 2011-12, WPI was up 8.9 per cent, whereas gold prices were up 33.5 per cent. Also, gold prices also have been less volatile than equities in the last five years.

Thus, gold turns out to be a better option than other financial products. As such, demand for gold in India grew at 39 per cent per annum between 2009-10 and 2011-12, compared to 24 per cent at the global level. However, its attractiveness creates problems in macroeconomic management.

India’s gold imports have been relatively price-inelastic. Despite gold prices in dollar terms increasing by 26.4 per cent and 27.2 per cent in 2010-11 and 2011-12, the volume of gold imports increased by 12 per cent and 9.2 per cent, respectively. But that is precisely why gold must be made dearer.

The fiscal measures need to be supplemented with product innovations like inflation-indexed bonds, gold-backed financial products to reduce the demand for physical gold, imposing export obligation on bulk gold importers and measures to increase monetisation of gold.

(The author is Professor in Economics and Associate Dean, Xavier Institute of Management, Bhubaneswar.)