Government hikes import duty on gold to curb demand Import duty on gold raised to 6% from 4% in an effort reduce the widening current account deficit

India on Monday raised the import duty on gold to 6% from 4%, stepping up efforts to curb the import of the yellow metal—a major contributor to the widening current account deficit (CAD) in Asia’s third-largest economy.

Besides hiking the tax, the government also proposed to link gold exchange-traded funds or ETFs and the gold deposit schemes of banks to encourage investors to use existing gold stock in the domestic market. This will release a part of the gold physically held by mutual funds under gold ETFs and enable them to deposit the gold with banks under the deposit scheme, the government said.

The government has also proposed some changes in the way gold deposit schemes operate to make the products attractive for investors. The minimum tenure of deposits will be reduced to six months from three years, according to the proposed changes.

While the government’s actions are intended at discouraging import of physical gold to the country, experts warned that the measures could encourage smuggling of the precious metal and make gold a less attractive option to invest.

“Unofficial channels (in the gold market) are likely to increase following the hike in import duty,” said T. Gnanasekar, director of Mumbai-based commodity and forex research firm Commtrendz Research and Fund Management.

“Overall, the move is also negative for the gold market as it can put pressure on prices and will cause the investment demand to come down,” said Gnanasekar.

Domestic gold price stood atRs.30,396 per 10g on Monday, up 0.25%, according to data on the Multi Commodity Exchange of India Ltd. It has risen 11% in the past one year.

Import concerns

Rising import of gold has been a major concern for the government and the Reserve Bank of India (RBI) as it has been put pressure on India’s widening current account deficit. The deficit, which is the difference between a country’s import and exports of goods, services and transfers, rose to a record high of 4.2% of gross domestic product (GDP) in 2011-12.

Transfers comprise currency transfers by one country to another in the form of aid or donations. A high deficit means a significant erosion in a country’s foreign assets.

In the July-September quarter, the deficit widened to a record 5.4% of GDP.

Gold imports constituted 11.5% in India’s total imports basket in 2011-12 in value terms, growing from 6.9% in 2008-9.

In 2011-12, India’s gold imports amounted to $56.5 billion. In the current fiscal year up to December, gold imports are estimated at $38 billion, according to official data.

In the 12 months ended September 2012, India’s gold demand stood at 793.1 tonnes, down 28% from the year ago period, according to data from the World Gold Council (WGC).

The fall in demand was attributed to rise in gold prices in 2012 and failed monsoon in some parts of India that lowered the purchasing capacity of people, according to WGC.

According to Indranil Pan, chief economist Kotak Mahindra Bank, any effort to curb the gold imports could have an impact on the domestic currency, which will, in turn impact prices.

“This move will make gold expensive, but it is very difficult to see what the real effect will be. If you are trying to stop gold imports, it could appreciate the rupee, and that could offset the rise in gold prices,” Pan said.

According to Pan, by linking the gold ETFs to the deposit scheme, RBI is trying to unlock a bit of the gold holding. “It will help RBI to meet the internal demand. But one will have to see the amount of the ETF gold holding to gauge the real impact of this,” Pan said.

Announcing the measures, the finance ministry said it has consulted with sectoral regulators Securities and Exchange Board of India (Sebi) and RBI to effect the changes. The respective regulators will issue circulars in this regard, the release said.

“There will be a definite reduction in gold imports in the near future, but it is too early to say whether there will be a reduction in the long term as well,” said Nayan Pansare, an independent gold analyst in Mumbai.

According to Pansare, the demand for the yellow metal will rest on the economic factors and will be driven mainly by rural India. Demand for gold is likely to be robust, provided the country sees a good monsoon, he said.

Currently, India has two gold related schemes—gold ETF and the gold deposit scheme. 

In gold ETFs, offered by mutual funds, units are sold to subscribers through ‘authorized participants’ and are traded on the exchange. The units are backed by physical gold held by the mutual funds. Money collected under any gold ETF is invested by the mutual fund in gold or gold-related instruments.

On the other hand, gold deposit schemes are offered by banks. Under this, banks accept gold deposited by clients and the gold is on-lent by the banks to the gems and jewellery trade.

At the end of the deposit period, the depositor is entitled to a return of physical gold or its equivalent in cash at the current market price of gold.

“The deposit scheme has a limitation. Most of the gold available in India is in jewellery form (that cannot work in deposit schemes). A lot of gold is available with temples also, but that too is in jewellery form. It is a beginning, we will have to see how the deposit plans work. It is likely to be slow initially,” Pansare said.

Recently, an RBI panel headed by K.U.B. Rao—an adviser to RBI’s department of economic and policy research— had proposed introduction of gold-backed financial products to discourage investments in physical gold.

The new products, according to the panel, could be in the form of gold accumulation plans, gold-linked accounts, modified gold deposits and gold pension products, the panel said.

Gold’s attraction stems from the metal giving the best return among all financial instruments during a period of high inflation, Nomura said in a report.

“Unless investors have options on other financial instruments, which provide an inflation hedge, we think import duties will only lead to a reduction in gold imports through the official channel and result in a simultaneous rise in gold imports through unofficial channels,” it said.