February 28, 2013

indian government's obsession with curbing physical gold investments

India's finance minister, Chidambaram, in today's budget, reiterated his dismay at the widening current account deficit. Imports of gold, along with crude petroleum imports and coal imports, were touted to be the drivers of a ballooning import bill of the country.

My blog post of January 3, this year (2013), dwelled on the adverse effects of subsidising gold purchases. The link to that post is here -->    

Early this month (February 2013) I contributed another editorial, in the newspaper I presently work for, on the issue of gold imports. This time, I wrote about RBI's effort to curb investments in physical gold. I believe it should be the government of India which should raise the import duty (customs tax) on gold and related products further (it is at an absurdly low rate even currently notwithstanding a recent marginal hike) and bring it at par with the average customs duty imposed on all non-gold imports. Additionally, it is not investments in gold which is a problem but the Indian culture of buying gold during marriages which is a problem. Much of that buying is through black money. The finance minister should get his Income Tax department to do far more than they are doing to tax those gold purchases.

Here is what I wrote in the editorial:

Who is more obsessed with gold?

RBI is desperate to curb gold imports so that rupee fall can be stemmed. But ad-hoc measures do not help in long term.

One only hopes that the central bank of our country is not feeling nostalgia over an old legislation called Gold Control Act, 1968, which was repealed in 1990. If RBI is indeed feeling so, it is for the wrong reasons and as a knee-jerk reaction to sustained weakening of the country's currency against the US dollar. With the alarming rise in the gap between exports and imports caused in part by rising imports of gold, and its consequent weakening impact on the Indian rupee. 

Alarm bells at RBI and other quarters have been ringing for the past several months. Now, a RBI working group has come out with its comprehensive report on issues related to gold imports and gold loans NBFCs (non-banking financial companies) in India. As expected, all its major recommendations have one objective -- prevent or deter further imports of gold into the country. But this single-point obsession of RBI has now begun to jar. Of course, reduced gold imports will curtail the existing high level of current account deficit, but RBI's most primary concern is that of stemming any further fall in the rupee. 

So, the question which needs to be asked whether, if global events change dramatically in the near future or medium term leading to an intense strengthening of the rupee, the various gold import-stemming products and ideas being hard sold now will be reversible. One, therefore, hopes RBI is not missing the wood for the trees. To the extent gold imports are aided on account of very low custom duty rate, even after it was recently hiked a little, there is a strong case to raise it the levels other imported goods face. 

Coming to the RBI working group's report, it began by stating that the basis of its central message was Indians’ obsession for large investment in physical gold. This could be half-truth because the obsession to acquire gold is there but it is not so much for investment purpose as for owning it in the form of jewellery for cultural reasons such as giving it in dowry during marriages and passing it down to future generations. It is also a form of holding black money. To the extent such acquisition is based on illegitimate or illegal grounds the objective is better served by a far better enforcement of the laws, including the taxation law, to deter future violators and bring to account existing ones. 

Going after investors in gold alone is not a smart thing to do. Investors, here and worldwide, include many who are vulnerable to wrong understanding of price movements. The price of gold has appreciated rapidly in the past few years and many investors tend to believe that this trend will go on forever, like they tend to do when equity markets are in the grips of bulls, and so they pump in more investments into it. Asset classes see cycles of bull and bear phases and gold is no exception. Even if gold is seen to be immune, at times, it is mainly on account of heavy instability in world economies and gold is seen to be a safe asset to hold. 

Why should RBI or anyone deny that freedom to an investor to hold what he perceives to be a safe asset regardless of whether his perception is sound or not? To be sure, some of the measures proposed by the RBI panel are progressive, regardless of RBI's motive. For instance, the proposal to allow banks to buy back gold coins is a step in the right direction. On a stand-alone basis, whatever progressive measures need to be taken with regard to gold-based acquisition, holding and financing should be taken and those specific recommendations of the panel should be adopted. 

But RBI needs to learn some lessons from the past. When the equity market was highly pumped up in 2007-08 thanks primarily to massive FII net inflows, the rupee had strengthened to such a level that RBI had pressurised Sebi to restrict the FII flows by banning participatory notes. At that time, exporters were getting hurt due to a strong rupee. The P-note ban was reversed later on. 

But can some of the not-so-progressive and desperate measures being mooted now to curb gold imports and stem net outflow of rupee be that easily reversible when the tide turns later? Ad-hocism by any financial regulator is never wise. 

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