Will India Glitter?

Feb 28, 2011

With the Union Budget 2011 , just around the corner, there is a lot of speculation about the announcements that will be made by the Finance Minister. Although during the previous budget, the government went vocal with its intent to curb inflation, it has received flak for its inability to control prices. Let's have a look at whether gold will glitter through this year's budget or not.

In a recap to last year: India's gold consumption reached peak levels of an estimated 800 tonnes even though prices surged to an all-time high last year. This spike in demand was influenced mainly by expectations that gold prices would continue to rise. Hence, there were those who thought that it would be the right time to purchase when price levels were relatively cheaper and earn profits as the price increases.

However, for such buyers, the recent fall in price has been quite disappointing. Short term markets are influenced by liquidity and sentiment values and are not based on long term fundamentals, hence it's quite difficult to understand and predict what might actually happen in the short term.

A breather for investors comes in the form of an increasing probability that the price of gold in Indian Rupees may move higher in the short term under the influence of the policy changes that may be brought up during the 2011-2012 annual budget where the Finance Minister is likely to announce an increase in customs duty for the third time in a row.

To provide a little more insight on the upcoming budget, here is a brief analysis created using extracts from the previous 2 Budget Speeches where there was an increase on the customs levied on gold

• 2009-2010: "Gold bars currently attract customs duty at the specific rate of Rs.100 per ten grams while other forms of gold (excluding jewellery) are chargeable to a duty of Rs.250 per ten grams. These rates were fixed in 2004 and have not been reviewed even as the price of gold has increased manifold. I propose to partially restore the incidence by increasing these rates to Rs.200 per ten grams and Rs.500 per ten grams respectively."

• 2010-11: "The prices of precious metals continue to rise. Since the customs duty is levied on these at specific rates, I propose to index the rates as follows: On gold and platinum from Rs.200 per 10 grams to Rs.300 per 10 grams."

The increase in gold rates, the rise in customs as well as the record level gold purchase and consumption in 2010 will provide the Finance Minister a window to further hike the customs duty on gold.

Gold Prices and Customs Duty

As estimated in the below table, there is a high possibility that the customs duty will be increased further by Rs. 100 to Rs. 400 per 10 grams of gold. This would adjust the customs duty expressed in percentage of gold price to be around 1.8 - 1.9% to match the levels of the hike in customs duty during last budgets. Also, going by the Finance Minister's speech on the rise of prices of precious metals, "Since the customs duty is levied on these (precious metals) at specific rates, I propose to index the rates on gold and platinum, from Rs.200 per 10 gm to Rs 300 per 10 gm." This indicates that a specific level of customs duty expressed as a percentage of gold price would be maintained.

Table: Gold prices and customs duty

Source: LBMA, RBI, Quantum AMC and http://indiabudget.nic.in/

Can the increase be any higher?

Based on the revisions made in the customs duty over the last 2 budget sessions and considering the above table, there is a high chance that there could be an increase of 32% in the customs duty slab when expressed as a percentage of gold price. A 32% increase in slab rate would mean a customs duty rate of 2.4% in terms of percentage of gold price. This in turn could translate in a customs duty of nearly Rs. 500 per 10 grams in the coming budget.

Looking at the previous budgets, it looks increasingly probable that the hike in customs duty would be at least to the tune of Rs. 100, hence raising the customs duty from Rs.300 per 10 grams in 2010 to Rs. 400 per 10 grams in 2011. However, given that the attitude of the consumer towards gold purchase was not affected even with the price escalation, there is a high chance that there could be a much higher increase in customs duty for 2011-2012. In such a case, the increase could also be close toRs. 200 per 100grams, thus raising the customs duty level to Rs. 500 per 10 grams.

With the Indian consumer's fascination towards gold and inflation on a rise, only time will tell how the budget will actually deal with this glittering spectacle that is one of the best keepers of value.

This is first of a 2 part series on customs duty on gold and government polices and reforms required for gold markets.