On 21^st January 2013 government raised the import duty on gold by 2 percent to 6 percent; this is the second hike in one year. Before this, in March 2012 government lifted import duty to 4%. On the very next day government increased the import duty on gold dore bars to 5% from 2%. Government’s action to pull up the import duty on dore will bridge the gap on import duties on bullion bars and dore, which had become an attractive import since April 2012, when the government doubled the tax on refined gold purchases from abroad to 4%.

What forced Government to take this action?

India is the world’s biggest importer of gold. For the past few years India imports gold around 800-1000 tonnes a year. According to the World Gold Council imports of gold by India stands at 223.1 tonnes out of 742.8 tonnes of the total world demand in the third quarter of this year, which is 9 per cent higher compared to same quarter of the previous year.

The decision of import duty hike is primarily aimed at trimming rising Current Account Deficit by discouraging investor from buying gold. Presently rising imports of gold have worried the government, which is battling a record high current account deficit. India imported $56.5 billion worth of gold in 2011-12, and by the end of December 2012, the country had already made purchases worth $38 billion. Gold has the biggest contribution on India’s current account deficit after crude oil. India’s current account deficit reached an all-time high of 5.4 per cent of gross domestic product in the July-September quarter. Due to the broadening current account deficit, mainly driven by large scale gold imports, the government was forced to raise the import duty on gold.

Finance minister Mr. P. Chidambaram had indicated that government will take measures to bring down the imports of gold after the release of unfavorable economic data on 2^nd January anticipation of import duty hike led to a 15% increase in January import of gold to 75 tonnes as compared to the 65 tonnes of January 2012.

Gold: A Sound Investment

Gold is the most attractive asset and a savings instrument which gives nearly 30 per cent returns annually. Investor flock to gold as the metal is an excellent hedge against inflation. In 2011-12, WPI was up 8.9 per cent, whereas gold prices were up 33.5 per cent. The influential factor that reduces the impact of import duty hike is India’s penchant towards gold for weddings and other religious ceremonies. 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.

Government prior steps became worthless

Historically, currencies were backed by gold. Government of India introduced gold control order in 1963 and gold control act in 1968 to control the gold related activities but these steps failed to yield the desired result. In 1963 after the border dispute with china, drains foreign exchange of India. To conserve precious foreign exchange Morarji Desai, finance minister came out with gold control order 1963 on which the production of gold jewellery above 14 carat fineness was banned, but this step didn’t work as per the expectation. In 1968 he imposed gold control act which prohibited citizens from owning gold in the form of bars and coins. All existing holding of gold coins and bars had to be converted to jewellery and declared to the authorities. Goldsmiths were not allowed to own more than 100g of gold. Licensed dealers were supposed to own between 400gm to 2kg of gold, depending upon the number of artisans employed by them. They were banned from trading with each other. However gold control act also failed to curb the import of gold. The response of the act was completely unexpected; it encourages the smuggling of gold. Indians denied the step of Morarji Desai and follow the unofficial and illegal path.

In early 90’s gold control act was abolished when Government of India had to transfer 40 tonnes of gold to London and swap for foreign exchange to tide over the country’s balance of payment crisis. After abolition of act government placed import duty on gold of Rs 250 on per 10 gm.

Impact of import duty hike on gold

Recent step of import duty hike, industry experts believe that it will only have a moderate effect on gold demand. As on date of announcement gold price went up by 1% and touched Rs.30847 mark at MCX on February contract, but the continuous appreciation of Indian rupee against dollar mitigated the rise to some extent. On 2^nd January, February gold contract was trading at around Rs.31000 and USDINR January contract was trading at 54.5675. On the expiry day of USDINR i.e. January 29, the USDINR contract closed at 53.6975 and as can be seen that due to the appreciation of the INR Gold also went down to Rs.30234 The depreciation of USD against INR is mainly attributed to economic slowdown in US.

Chart showing daily return on GOLD and USDINR

India’s government also took series of steps last year to reduce gold imports, including an earlier increase in the import duty and banning banks from lending money to customers to buy gold. In beginning years of 21^st century when the import duty on gold was 1%, import of gold was around 800 tonnes. In the year 2011 import duty was increased to 2%, and then country imported around 1,000 tonnes. In 2012, government raised duty to 4% and still country imported another 800 tonnes of gold.

Final thoughts

To summarize, it is very difficult to say that hike on import duty on gold will curb the demand as gold has always been regarded as best investment to hedge against inflation. By raising duty, it will only encourage illegal channels to replace official import channels as gold is required from birth till death in Indian tradition. Import duty hike on bullion has widened the gap between the Indian and international prices and this will force people to choose the smuggling route and illegally bring yellow metal in the country. Smuggling of gold has been increase by 8 times in current fiscal year compared to previous year and becomes headache for the Directorate of Revenue Intelligence (DRI). During current fiscal year DRI has seized Rs. 60.17 crore of smuggled gold, but India imports illegally much more to this. According to DRI officials they detect about 1 case in every 10 cases.

To discourage investment in physical gold government should introduce alternative financial instrument which provide an inflation hedge, attractive gold related schemes and gold backed financial products.