The government is being antediluvian by raising the import duty on gold. The official reasoning being that higher taxes will make gold imports more costly and tame India’s legendary appetite for the yellow metal. What will most likely happen is supplies will move to unofficial channels, depriving the government the revenue it is deriving now from legitimate imports. Finance minister P Chidambaram set the ball rolling by announcing earlier in the month that the duty would be raised. Bullion orders have re-acted already, prices are expected to follow Monday’s decision. But all this will do little to arrest demand. India imported more gold after the customs duty was raised less than a year ago. The only tangible gain is in national income accounts: by shifting gold supplies into contraband territory, the current account deficit should look healthier than the 5.4% clocked in June-September 2012.
Gold exchange traded funds were launched in India on the premise that the underlying asset — typically one gram of gold — would be available for redemption at any point by its owner. By allowing gold funds to lend some of their bullion to banks, holders of paper gold will move to fractional ownership, where the underlying asset does not reflect the market price. Hybrid products like these have been prone to excessive speculation in western markets. The regulators will have to weigh the higher risks of fractional gold holdings against the gains of having more domestic bullion in circulation.
The 1962 gold control order banning ownership of coins and bars pushed the entire trade underground. From 1992, when the government re-allowed official imports, demand has been climbing steadily, as India keeps buying more gold than any other country despite a 12-year international bull run in bullion prices. A forward-looking solution would have looked at providing Indians a credible inflation hedge that can ease the pressure to buy gold and expand financial intermediation to the countryside where most of the people have no option but to salt away their savings in jewellery. There has been talk of both. But the former is hamstrung by the fact that India does not have an accurate gauge for inflation yet.