Precious little logic

The Government’s decision to hike the duty on gold imports from 4 to 6 per cent is the latest of its desperate moves to ‘moderate’ domestic demand for the yellow metal. By making it costlier or directing non-banking financial companies (NBFC) not to extend loans beyond 60 per cent the value of jewellery offered as collateral, the attempt is clearly to reduce the attractiveness for the public to buy or even use gold as a source to secure credit. These measures are unlikely to work. Duties that raise the wedge between domestic and international prices would only promote smuggling, the chances of it being higher in a product, where a single kg alone is worth over Rs 30 lakh. Restrictions on gold loan NBFCs, likewise, would only drive borrowers to pawnbrokers and other unregulated entities.

The basic point here is that the Government is trying to curb demand for gold, without going into the underlying reasons. It is true that physical gold imports into India almost doubled from 537 tonnes in 2007-08 to 1,004 tonnes in 2010-11, before falling to 891 tonnes last fiscal. But this surge had mainly to do with two factors. The first is inflation and the public seeing returns from bank and post office deposits, equities or mutual funds providing inadequate compensation. The second is the global financial crisis that engendered a general evaporation of trust in fiat currencies, leading even central banks to hold a larger portion of their reserves in gold. That was a major impetus for gold prices to surge from an average of under $ 700 in 2007 to nearly $ 1,600 an ounce in 2011. As these got transmitted into India and the public witnessed this one asset giving 25 per cent or more average annual returns, they dumped everything for gold. That, in turn, further boosted demand, prices and imports, each feeding into the other. The Government’s inability to control prices – caused no less by its fiscal extravagance spilling over into generalised excess domestic demand – only added to gold’s image as a reliable long-term inflation hedge.

All this only reinforces the case against drastic measures that only end up driving businesses underground. The possibility of that happening in gold has been seen in the past too, where the policymakers again only sought to address the symptom, not the cause. A better way to tackle the cause, apart from fiscal discipline, is to give the public enough reason for entrusting their savings with, say, banks other than just safety or guaranteed return. There is definitely no reason to treat interest on bank deposits as income that even gets taxed at the highest marginal rates. Eliminating tax on interest income will at least provide some level-playing field vis-à-vis gold, where the bulk of transactions take place in cash and go totally untaxed.