The recent hike of import duty on gold by another 2 per cent by the Government has brought the total import duty on the bullion to a total of 10 per cent. Similar hikes were imposed on other precious metals with an aim to deter consumer demand, which would lead to reduced need of foreign currency.
The Government seems to be benefiting irrespective of whether strategy works or fails. The milking of gold hungry Indian consumers may seem an attractive strategy, but it also has negative side effects of which Government should be aware.
The unexpected introduction of import duty in last few months took the market by surprise. Especially for gold consumers for which India is known, import duty was essentially a tightening mechanism to control the demand for Dollar, a currency against which Rupee is falling unabatedly. The strategy does not seem to be working at the moment.
After gold price crashed significantly in last few months, Indians recorded a whopping 162 tonnes of import of bullion in the month of May. Imposing massive duty did bring the official import figures in control. The month of June clocked some 31 tonnes of import. However, the fresh dose of duties had slowed down Indians temporarily. The July figures are showing rising trend again prompting government to increase the dose.
The deliberate tightening induced in the system may have caused pain all across; the Government seems to be the only happy customer. The strategy to increase import duty has double benefit. Including the recent round of hike on precious metal, the government has created additional revenue of Rs 20,000 crores. This should help quell some pressures on Fiscal Deficit, even if the ploy to curb the fall of Rupee against Dollar had marginal success. Improved fiscal scenario will have positive impact on the currency. It is apparent the Government is trying to kill two birds with one stone.
There are apparent side effects though. A high import duty puts official gold at a disadvantage to unofficial gold. As the largest importer of gold, price arbitrage between official and unofficial commodity opens a potential grey market. The grey market of gold could potentially be worth `20,000 crore. The unofficial money is likely to flow in the system through Indian 'hawala' system of money exchange, evading the official system. This money is certainly going to impede government's plans to improve Fiscal and Current Account situation.
Besides, the Government must also be vigilant to not let the smuggling network grow. India cannot afford another regime of organised crime as it faced in 70s and 80s. Unofficial money source strengthens the network of organised crime significantly impacting the mainstream economics of the country. The death of organised crime in the 90s was possible primarily because gold trading was legalized sucking away the main source of funds from the mafias. The introduction of import duty on gold has opened up a fresh avenue of funding for the mafias. We can expect that unwelcome machinery to become activate again.
With import duty already high, people are wondering if it could go even higher. The Government seems determined to take every possible action to impede gold import. But as they say, in economics, every strategy draws out double-edged sword - it cuts at both the ends. Benefiting from our appetite for gold may be filling the state coffers, but, is the sword cutting at the other end tooIJ
(The writer is Director, InvestCare, leading wealth advisors. You can reach him at samar.vijay@investcare.in)