Curb this appetite for gold

Parkash Chander | Updated on July 31, 2014

Enough is enough Can we think of weddings without gold? NAGARA GOPAL

Merely tweaking import curbs won’t do. An innovative gold deposit scheme and demand reduction measures are required

Following a steep rise in the current account deficit and declining forex reserves, the Indian Government raised the gold import tax last year to 10 per cent from 4 per cent, and introduced the 80:20 rule last July, which requires that 20 per cent of all gold imports have to be re-exported.

As a result, official gold imports have plunged, reducing the trade deficit and, therefore, the CAD significantly. However, India’s appetite for gold continues unabated and some of it is now being fulfilled through smuggling. According to the World Gold Council, 150-200 tonnes of gold entered the country through unofficial channels in 2013. So, the curbs on gold imports and high import tax cannot be kept in place for too long.

But periodically adjusting the import tax and imposing sundry restrictions in response to the ebb and flow of foreign capital does not address the real problem, which is India’s huge appetite for gold.

The demand scene

The demand for gold has two main components: jewellery and investment purchases. Jewellery demand is by far the largest. Despite higher domestic prices of gold, jewellery demand was up by 11 per cent in 2013 over the previous year.

Approximately 28 per cent of India’s total population of more than 1.2 billion is in the 15-30 year age-group. That is a very large number of young people who are likely to marry over the next 15 years. Since marriages in India seldom take place without some gold jewellery for the bride, the demand for gold, unless controlled, will increase manifold over the next 15 years.

At the height of a worsening CAD, the then finance minister P Chidambaram appealed to Indians to buy less gold. They responded by buying even more gold. If the Government is really serious — as it should be — about taming the Indian demand for gold, advertisements promoting gold jewellery ought to be banned.

Indians prefer 22 or higher carat gold jewellery. Banning the sale and purchase of gold jewellery of more than 18 carats will benefit consumers, make gold jewellery of 18 and less carats socially acceptable and, most importantly, reduce India’s demand for gold.

The production of gold jewellery of 22 or more carats may be permitted, if at all, only for export. These two measures may not, however, be effective in the rural areas. Gold is extremely important for liquidity in rural India as banking penetration is low. Greater banking penetration, spread of micro-financing, easy availability of consumption loans against other assets such as cattle, land and so on can reduce rural gold demand.

What about the artisans?

The impact on the estimated 3.5 million artisans employed in the gold industry is a concern. Both, the Government and the jewellers have to accept the fact that if India is to reduce its demand for gold, the industry has to innovate and change. Switching to semi-precious stones and fashion jewellery — beside gold jewellery of lower caratage — can keep the industry growing.

Over the years, Indian households have accumulated 20,000-25,000 tonnes of gold. Previous attempts to tap privately held gold by floating gold deposit schemes floundered mainly because of low returns. Something different is needed. An analogous scheme to the Foreign Currency Non Resident (FCNR) deposits for resident Indians to hold foreign currency deposits in exchange for gold can contribute to India’s gold reserves without diminishing its foreign currency reserves.

Under this scheme a resident Indian can hold a foreign currency resident (FCR) deposit by depositing gold of equivalent value with a designated bank. On maturity, the FCR deposit maybe either renewed as a new deposit or redeemed in rupees at the prevailing exchange rates. No foreign currency or interest earned goes out of the country and the gold deposited becomes part of the Reserve Bank of India reserves. The FCR deposits can have tax-free flexible interest rates in step with those on FCNR deposits. Rupee loans can be allowed against FCR deposits.

The proposed FCR deposits will be a good alternative to owning gold for those who buy it as a hedge against inflation and protection against risk of rupee depreciation.

A few safeguards can prevent the misuse of FCR deposits. First, the interest rate on FCR deposits should never be higher than the interest rate net of taxes on rupee deposits. Second, PAN should be mandatory for all gold related transactions so that a paper trail is created to track new sales/purchases and ownership of gold.

The writer is a professor at the Jindal School of Government and Public Policy

Published on July 31, 2014

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