Given the doubling of May imports of gold, after a 150% year-on-year hike in April, the government has pinned a lot of hope on an import duty hike from 6% to 8%, and the slew of measures announced by RBI on Tuesday to curb gold imports—raising cash margins on letters of credit for gold imports to 100% and extending the restrictions on consignment imports by banks to agencies like STC/MMTC and star trading houses. The problem is that such sand-in-the-wheels solutions, to use chief economic advisor Raghuram Rajan’s phrase, don’t work when the wheels are churning at the kind of speeds suggested by the April and May numbers. There is little doubt that if gold imports by MMTC and STC-type of agencies is reduced, it will help; but this assumes a genuine demand will not be met by other enterprising entrepreneurs including smugglers. In which case, more structural solutions are called for. Needless to say, while gold imports are causing a problem right now in terms of the CAD, the problem is dramatically exacerbated by the collapse in exports and the large surge in imports of commodities like coal, the result of a policy that perpetuates Coal India’s monopoly.
The larger structural issues that need addressing, for instance, relate to the fact that Indians are simply not saving enough in other instruments, indeed they are disinvesting in them. Fresh inflows into insurance, for instance, fell 10% year-on-year in FY12 and then by over 6% in FY13. In the case of mutual funds, the value of assets under management in equity funds has fallen from R1,66,500 crore in December 2012 to R1,55,200 crore in April 2013 even though the Sensex rose marginally during this period. Since a large part of the fall was due to a reduction in commissions paid to agents for what are essentially push-products, you would have thought the sector regulators would have got together to sort this out. If gold sales are rising despite the fall in gold prices—at $1,404 per troy ounce, gold prices are trading even below the Goldman Sachs 2013 forecast of $1,600 and way below its earlier 2013 forecast of $1,810—there is clearly a larger issue that needs addressing. Indeed, gold has delivered a return of minus 46% in inflation-adjusted annual terms over the past 3 months, minus 34% over 6 months, and minus 13% over a year. Over a decade, the Sensex delivered 13.6% inflation-adjusted returns per year versus 9.6% for gold—depending on the tax bracket, the returns fall for gold since capital gains taxes apply to gold but not to shares over the long term.
Though the KUB Rao committee had suggested various innovative solutions to tackle gold imports in February, the response to them has been quite lacklustre. Inflation-indexed bonds, which Rao had recommended, have been issued in niggardly amounts and could do with a hefty increase. Little has moved on the other suggestion of dematerialisation of gold. Allow wannabe investors, for instance, to buy gold ETFs from banks which book contracts for gold in overseas futures markets. Since physical gold will only have to be imported in case buyers want their investments back in gold after a period of time, this reduces import demand considerably. Given that around 40% of those buying gold do so in the form of coins and bars, it is investment-demand that is driving imports, not consumption-demand. These are areas the government needs to move on, yesterday’s measures are likely to be of just limited use.