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Unchaining the golden bond

business Updated: Jan 22, 2013 21:54 IST
Gaurav Choudhury

The government on Monday raised the import duty on gold and platinum in a bid to contain the current account deficit that has reached alarming proportions. HT explains the linkages between gold imports, balance of payments and foreign exchange movements:

What has the government announced?
The government on Monday raised the import duty on gold and platinum by two percentage points to 6% to discourage imports by the pushing the precious metals' landed price to rein in the current account deficit (CAD) that has hit a record high.

How has it affected prices?
On Monday, gold prices jumped by Rs 315 to trade at Rs 31,250 per 10 grams in Delhi immediately after government increased import duty on the metal.

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Will this help curb gold imports and, if so, by how much?
According to experts, in the past, imposition of import duty has had some salutary effect in moderating official gold imports. In March 2012, the government doubled the import duty on gold from 2% to 4% resulting in a 25% drop in gold imports during the first three quarters of 2012.

What is current account deficit?
A country's BoP statement is divided under two major heads-the current account and capital account. In any economy, foreign exchange movements take place through two routes. Investments come into India such as foreign direct investment (FII), portfolio investment in India's stock markets, overseas borrowing by Indian companies from foreign banks come through the capital account because these funds are used over a period of time. On the other hand, there are expenses and income that are "current" in nature. These include export earnings, import payments, earnings from intangible services exports (such as tourism), a credit of income such as when an individual receives funds from a foreign entity and current transfers as foreign aid and donations.

How is the current account calculated?
The current account is calculated by the formula (X-M)+NY+NCT --- which the net export earnings over import payments, net foreign income and net current transfers.

What does a deficit or a surplus in the current account signify?
A current account deficit means that there is more outflow of capital from the economy than inflow, which is not desirable.

What's wrong with India's CAD?
Economists have attributed India's widening CAD to rising gold imports among other factors. The CAD has widened to 5.4% of GDP during the quarter and to 4.6% of GDP during the first six months of the current fiscal year-a worrying sign for a slowing economy where fulfilling immediate dollar payment obligations may necessitate dipping into the pool of foreign exchange reserves

Will a fall in gold imports not hurt the jewellery trade?
The government has proposed changes in gold exchange traded fund (ETF) that mutual funds offer to enable linking these to banks' gold deposit schemes. The objective is to unlock a part of the gold physically held by mutual funds under gold ETFs and enable them to deposit the gold with banks as gold deposits. The intention is that a part of the gold lying in stock will be brought into circulation and will partially meet the requirements of the gems and jewellery trade.

Why do people invest in gold?
Gold is one of the several assets that people invest in. Unlike equities or bank deposits, gold is a physical asset and has been a traditional favourite for parking surplus income.

Why were gold prices rising over the last year?
Gold is considered a safe haven asset. With inflation high and stock markets volatile, gold prices have hit an all-time high.

The price has risen 35% over the last one year as investors in Europe and the US added gold to their investment portfolio, rather than parking funds in unstable and risky equity markets.

How big is the Indian jewellery market?
India is the world's largest market for gold jewellery, accounting for most of the nearly 1,000 tonnes of gold imports in 2011.

What drives gold demand in India?
The motivation for a jewellery purchase is linked to value, wealth preservation and growth rather than pure adornment - there is therefore little distinction between investment and jewellery demand in India. Purchases relating to weddings typically account for 50% of annual jewellery demand in the country. With 50% of the Indian population under 25 and approximately 150 million weddings anticipated over the next decade, the World Gold Council estimates that wedding-related purchasing will drive approximately 500 tonnes a year.