As India approaches Budget 2022-23, it is a good time to recall that in last year’s Budget, the government had announced a reduction in the basic customs duty on gold from 12.5 per cent to 7.5 per cent. An additional cess of 2.5 per cent was also imposed, taking the effective customs duty to about 10.75 per cent (including surcharges).
Cut to the beginning of 2013, when the customs duty on gold stood at just 4 per cent. However, by the end of that troubled year, it had shot up to 10 per cent after three hikes in quick succession.
The year 2013 was, of course, when India’s current account deficit had ballooned to alarming proportions and when we were on the verge of a ratings downgrade, following a sharp depreciation of the rupee. A drastic response was the need of the hour and, predictably, the axe fell on gold imports. Since then, India’s forex reserves have increased from $280 billion to a comfortable level of over $630 billion today. But the customs duty on gold has not budged.
Is there, then, a case for reducing the customs duty on gold? Yes, there is, and it goes well beyond the usual complaint about how it has needlessly revitalised gold smuggling.
One widely reported estimate suggests that 25 per cent of all the gold coming into India is smuggled in. That’s more than 200 tonnes on an average every year. Between 2015 and 2020, about 11,000 kg of gold, worth over Rs 3,100 crore, were seized in 16,555 gold smuggling cases across various Indian airports, according to government data. Bleak as these numbers are, the case for lower customs duty on gold rests on more fundamental factors.
“Barbarous relic”
In 1924, the influential economist, John Maynard Keynes, referred to the gold standard (and by implication gold) as “a barbarous relic”. Economists and policymakers have long disdained gold, more so in India where a good part of household savings goes into gold. It is considered negative for economic development as the gold ends up in safes and vaults, and is not available for circulation in the economy. Moreover, India depends on imports to satisfy the vast domestic demand for the precious metal. Gold is seen as something that consumes precious foreign exchange while contributing little to the economy.
There is merit in these arguments. But policymakers have erred in treating gold as a consumption good. For the poor and unbanked in India, it is more of a financial asset. About 60 per cent of the gold jewellery bought in India is in rural areas. It is the preferred avenue to park one’s savings. After harvest, farmers with surplus money buy gold because they don’t have access to banks. Later, in the sowing season, when they need money the most, they may sell the gold or pledge it to avail small-ticket loans.
In recent years, India has made great strides in improving access to bank accounts. But access to credit for the masses is still work in process. Further, as economist Ila Patnaik once pointed out, gold is particularly important in shifting power within poor families to women, as they get to own a financial asset that is liquid, and useful as collateral for taking a loan. Gold, in a sense, is our own traditional way of empowering women and giving them a voice.
The default inflation hedge
Indians have long invested in gold simply to preserve their wealth. Recurring bouts of high inflation have eroded faith in paper currency, making gold the default hedge against inflation. Importantly, this distrust of paper money is not in the rupee alone.
Ever since the global financial crisis of 2008, the US has printed dollars on a massive scale, euphemistically called “quantitative easing”. At the start of the global financial meltdown in 2008, the US Federal Reserve had assets worth about $870 billion on its balance sheet. By 2015, it had increased to $4.5 trillion. Today, after the shock of the pandemic triggered another frenzied round of quantitative easing, it stands at $8.8 trillion.
On August 15, 2021, the world marked the fiftieth anniversary of President Richard Nixon’s announcement of the end of the gold standard, which committed the dollar’s conversion to gold at the rate of $35 per troy ounce. With the peg to gold gone, the dollar became a fiat currency like any other, with no limits on its printing. Over the five decades since, the price of gold has appreciated to $1,800 per ounce, for a CAGR return of 8.2 per cent. That is a very decent rate of return for a 50-year period. Factor in the depreciation in the rupee, going from Rs 7.5 a dollar to Rs 75 a dollar over this period, and the returns are truly substantial. The faith that ordinary Indians have always had in gold stands vindicated. As for the class of policymakers and economists who presume to know better, maybe it’s time they changed their latitude.
The gold ecosystem
The strongest argument for reducing customs duty is related to what it can do for the economy, chiefly through employment generation and export promotion. However, for this to come about, we must turn away from the bean counting around forex outflows to the positive externalities that would likely present itself over time. India’s fascination for gold has endured over centuries. The outcome is that a flourishing ecosystem has evolved around gold, which provides employment across the value chain to about 4.6 million people with a skilled artisan class at its core. In a world where people pay a premium to get away from the me-too uniformity of machine-made goods, we can leverage this talent pool to make hand-made jewellery for discerning buyers abroad. That should not be a tall order. Once you have policies to encourage and expand the base of the pyramid (of this class of artisans), you can expand to compete in the export market. But then, as things stand today, the hordes of NRIs who visit India each year spend on their favourite food and clothes but stay away from gold jewellery because our duties and taxes have made it an expensive proposition. In squeezing gold import and making it unduly expensive, we run the risk of throwing the baby out with the bathwater.
What about skyrocketing imports?
India’s gold import bill for calendar year 2021 set a record at $55.7 billion, against $22 billion for 2020. In volume terms, it amounted to 1,050 tonnes of gold, the highest in a decade. Does this negate the case for lower customs duty on gold? Not at all.
Every structural reform, and every new resolve that demands a change in attitude, begins with an upfront cost. The key is to look at the outflows of forex on account of gold imports as an investment for the future. Follow up with concerted policy action to ensure that India’s gold ecosystem generates employment and exports in equal measure. Let’s do this by investing in and building on India’s historical strength — its skilled artisan class — so that eventually the returns far outweigh the costs. What is needed is the foresight to see diverse elements falling into place to form a larger picture, where the initial costs and sacrifices go on to generate substantial value and returns over time. Yes, it is time to go bold on gold, and it begins with a bold vision.
(V.P. Nandakumar is MD & CEO of Manappuram Finance Ltd. Views are personal.)