september 14, 2013

Wages of Liberal Policies

A sink for unaccounted wealth, it will not be easy to reduce gold imports.
old has become the bane of Indias balance of payments. But it is amusing that all important government functionaries, from the prime minister and the governor of the Reserve Bank of India (RBI) downwards, now bemoan Indian societys appetite for gold without recognising that it is the liberal gold policies of the past two decades that have fed the domestic appetite for the yellow metal. India, no doubt, has always been the largest consumer of gold in the world. But after the Gold Control Act, 1968 was rightly scrapped in 1990 because it was ineffective, the pendulum swung to the other extreme. From 1991 onwards, a series of measures have been taken to facilitate supply from abroad restrictions on imports as part of personal baggage, on imports by private trade and by banks were gradually removed and customs duty was reduced by 75%. The government also revealed its intention to establish a Gold Trading Centre and make India a gold trading hub. Towards the end of 2003, after MCX became a major commodity exchange, forward trading in precious metals was permitted and, today, the turnover in gold and silver dominates the futures market in Indian commodity exchanges. All these measures naturally led to a perception that the government did not frown on gold imports. This perception was grounded in reality; it was actually promoted by senior ofcials who argued that a positive approach was demonstrably less disrupting and more consistent with the socio-economic conditions in the country than a negative approach to gold. This was despite conclusive evidence in economic history of Indian society being a bottomless pit for gold. The authorities refused to perceive the disturbing implications of the transfer abroad of huge amounts of hard-earned savings of the community in exchange for such an unproductive asset. The consequential results are there for all to see. For the World Gold Council (WGC), which has a commercially-driven mission to stimulate and sustain gold demand in the world, India is its best bet. A recent WGC study titled India: Heart of Gold Revival, covering the period up to 2009, states, Over the past decade, Indias gold consumption has increased at an average rate of 13% per year, outpacing the countrys real GDP, ination and population (rates of increases) by 6%, 8% and 12%, respectively. As per WGCs data, Indias gold consumption accounted for between 27% and 31% of world demand between
Economic & Political Weekly EPW

2010 and 2012. The bulk about 80% of gold demand in India has been in the form of retail jewellery, the balance being investment (18%) and industrial demand (2%). The resulting strain on the countrys balance of payments is well known. Next to petroleum products, gold is now the largest foreign exchange guzzler. Imports, from a meagre $4.12 billion in 2000-01, have risen nearly 14-fold to $53.82 billion in 2012-13. These imports constituted over 60% of the current account decit in 2012-13. It is unfortunate that the imports of valuables are included by the Central Statistical Ofce (CSO) as part of gross capital formation (GCF). For example, when GCF is reported as 35% for 2011-12, it included 2.7% of GDP or Rs 2,42,698 crore as valuables. The actual level of capital formation in that year was thus only 32.3% of GDP. This measures the extent of loss in capital formation year after year due to the diversion of such large amounts of savings towards investments in valuables. The Indian attachment to gold is not merely the result of economic factors. The WGC attributes this fascination to Indian culture. But gold does provide a sense of security for the weaker sections of society. The factors inuencing demand really are a mixture of the need for economic security, social status and cultural traditions, which, in turn, are reinforced by gross inequalities in the distribution of incomes and assets as also the widespread incidence of illegal or black money. With such a value system deeply ingrained in the social psyche and given such a grossly inegalitarian system of governance, weaning people away from gold is no easy task. But even within this broad structural environment, it should be possible to contain Indias gold consumption by putting in place a set of public policy measures that would discourage investment in this metal. Of course, this cannot be done by the draconian measures of gold control as in the past. But consumption can be curbed by three methods: promotion of nancial products, use of scal measures and introduction of administrative controls. In this respect, the recommendations of the RBIs K U B Rao working group (2012) deserve to be commended. For the rst time in three decades an ofcial document talked of policy measures to curb demand for gold. Subsequent to this report, the government and the RBI have undertaken a number of measures to curb gold purchases and imports. But coming 7

september 14, 2013

vol xlviII no 37

EDITORIALS

after nearly two decades of liberal policies, the impact will not be immediate. Insofar as the attractiveness of the nancial market as an alternative to gold investment is concerned, an imbalance will remain until a stable and healthy share market environment is created. As an overwhelming share of

investment in gold is believed to come from unaccounted money, scal policy with a system of progressive income taxation along with effective wealth and inheritance taxes could have played a signicant role in curbing gold imports. But, alas, this is not to be!

september 14, 2013

vol xlviII no 37

EPW

Economic & Political Weekly