India ponders deficit control after the gold rush

February 12, 2013

India’s central government in January raised the tax on refined gold imports by 50 percent. This increase to 6 percent from 4 percent is the second rise this fiscal year. Why does it keep making gold more expensive, particularly as the nation enters its prime wedding season when brides will be bedecked with the metal from head to toe?

That’s part of the problem — a large part. India’s cultural attachment to gold is something that anybody who has been to an Indian wedding could tell you about. For those of you who haven’t, consider this report from CBS’s “60 Minutes” TV news program:

“India’s love for gold is almost a religion. Beyond being a symbol of wealth and status, gold is part of worship and culture – a tradition that goes back thousands of years. From birth to death, for men and women, among rich and poor – acquiring gold is a goal for the people of India. All of which has made India the world’s largest consumer of gold and thus a powerhouse in industry … Just as part of the American dream is to own a home, the dream in India is to own gold. For Indians, gold jewelry is wearable wealth, financial security that’s also a fashion statement.”

CBS notes that half the gold that Indians buy each year is jewelry bought for a wedding. And as this Voice of America report says, India produces almost no gold, and imports 700 tons a year to feed demand. That’s half of 700 tons, sitting on India’s brides. It’s your savings, not to mention an inflation-proof investment. Here’s an enlightening excerpt from that report:

“A professor at the National Institute of Public Finance and Policy, N. Bhanumurthy, says this massive import bill is contributing to a trade deficit. He says gold also is seen as an unproductive investment. ‘More than half of the current account deficit has been contributed by the imports of gold in the recent period. The savings should be channelized for some investment activity. Gold is neither investment nor financial savings,’ he explained.”

Look at the numbers. India is the largest importer of gold in the world. Its gold demand has risen about 80 percent from 2002 until 2011, according to World Gold Council. Gold constituted 11.5 percent of India’s total imports in 2011-2012 in value terms, growing from 6.9 percent in 2008-2009. That means gold represented $56.2 billion of $489.4 billion in imports in the last year.

Rising gold demand widened the country’s current account deficit, or the amount by which imports exceed exports, to 5.4 percent of its gross domestic product during the quarter ending September 2012. That amounts to $38.3 billion. In fiscal year 2011-12, this deficit stood at 4.2 percent. That has led the government to say that it might raise prices again. If demand falls, that could help shrink the deficit and prop up the value of the rupee, which has been sagging lately.

That’s the government’s thinking, anyway. But such a move might not go far enough to help India’s economic problems. Also, a rising fiscal deficit coupled with slowing growth could push the country into a “twin deficit” situation, which could trigger the fears of currency crisis in 1991, when India had to pledge its gold reserves with International Monetary Fund to finance its mounting debt.

“Gold imports are manifestation and outcome of adverse macro, natural cultural affinity, and delivery of better returns as an asset class. These three factors have pushed gold demand at a humungous trajectory,” said Shubhada Rao, chief economist at Yes Bank. The implication there is that there is little other option than to raise the import duty.

Doing that also could encourage investment in other areas, whose performance might be strengthened by the funds of India’s swelling ranks of the middle class.

“If gold duty is depressing the demand to an extent, simultaneously, India’s growth prospects improve and inflation starts correcting, I will see equity returns start getting better or bonds returns getting better, I as a saver will switch from gold as an asset to equity or bonds,” Rao said.

But if the idea is to narrow the deficit, why not look at other options that could achieve more long-lasting effects than continuing to make gold more expensive? What about oil, which accounts for 30 percent of India’s total imports.

“If the government actually follows on its announcement on increasing diesel prices by 50 paise per litre, I think that will have more far-reaching impact on the overall import demand and thus the trade deficit,” said Anubhuti Sahay, an economist at Standard Chartered PLC.

“I think the policy that (the) government has initiated to raise diesel prices , aligning the domestic crude prices to the global crude prices … will eventually curb the demand. So there will be some rationalization of demand,” said DK Joshi, chief economist at CRISIL Rating Services. “Right now there is no incentive to conserve. So from that perspective consumption of oil will get reduced.”

When it comes to gold, Joshi said, India somehow will have to curb demand. But how do you change the behaviour of a billion people with long-standing traditions? Such a move, it seems, would demand more than government policy could readily provide.

(A man stands in front of a billboard advertising jewellery in Chennai in 2009. Reuters photo: Babu) man stands in front of a billboard advertising jewellery in the southern Indian city of Chennai March 4, 2009. India gold extended losses for a second day on Wednesday due to continued profit-taking, but buyers stayed away hoping for bigger falls in the midst of the wedding season, traders said. REUTERS/Babu

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