Reversal of Golden Reforms - Outside View by Chirag Mehta

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Reversal of Golden Reforms
Feb 28, 2011

Here's Part 2 of the Union Budget - 2011 Series.

If you have been with us through the first part of this series, you would already know why we think it very likely that the Finance Minister will hike the customs duty on gold.

But is this a justified move? Is the hike required?

Is the rise justified?

In order to validate the rise in custom duty, let's first understand why the customs came into existence.

Until a few decades ago, India was a self-sufficient, inward looking economy that was focused on reducing imports using import substitution and which supported scarce foreign exchange. And then in 1962, the Customs Act was established to protect local industries and prevent illegal import and export of goods.

However, over a period of time we saw transition, and the Indian government decided to open its economy to foreign business. The introduction of liberalisation reforms helped to free the gold market through unrestricted movement of currency.

And all went well till recently when the reforms were reversed and gold customs duty was increased. Ironically, India has been producing almost negligible quantities of gold in comparison to its consumption and hence there was no real requirement for custom duty to be levied, especially not by claiming protection for domestic industries.

Previous Budgets saw a reduction in customs duty. Here's a brief look at the justifications provided by the then Finance Ministers:

  • 2001-2002: "In order to discourage smuggling I propose to reduce the duty on gold from Rs 400 per 10 grams to Rs 250 per 10 grams."- Yashwant Sinha

  • 2003-2004: "As for gold, it is proposed to reduce the customs duty on imported gold to Rs.100 per 10 grams from the present level of Rs.250 per 10 grams, but only when it is brought in the form of serially numbered bars, or in the form of gold coins, not as 'tola' bars, please. It is my hope and expectation that this will become the first step in enabling India to shortly emerge as the gold-trading capital of the world."- Jaswant Singh
Those were their justifications, here are some of our questions that remain unanswered...

Where has the dream of making India the gold-trading capital of the world disappeared to?

Will increasing the duty on gold now not lead to smuggling?

India has all it takes to become a dominating power house that can control the gold market because of its great consumption power, huge gold stock reserves with individuals, and established exchanges and products that are needed for the development of the gold market already in place. However, instead of being a price driver, we have been categorized as price takers.

In today's date, customs duty has become a major revenue-earner for the country and this dream of making India the gold-trading capital has been sacrificed for the sole purpose of filling the government coffers in a bid to reduce the deficit. This is done by burdening consumers who are already under the pressure of rising prices; and all the while the basic intention behind its introduction lies conveniently forgotten by the concerned authorities.

Our Appeal

Government policies play a big role in making or breaking the market. Hence, we urge the Finance Minister to stay uninfluenced by the short term gains of the custom duty and look towards the complete development of the gold markets in India.

By introducing Gold ETFs in 2005-2006, the then Finance Minister took a step forward and enabled investors to buy and own gold more efficiently. We need more steps like these to make the gold markets much stronger.

A few other reforms that can be introduced to fulfill the dream of making India the gold-trading capital of the world:
A gradual move towards a free market, which allows imports and exports including that of gold to be made freely or with minimal restrictions. While there is a high chance that domestic prices are not at par with international prices due to excessive price fluctuations, this is unlikely to happen in a free market and would thus serve as a stepping stone towards India being the center of the gold market.

Get domestic prices on level with international prices so as to bring about an efficient two way transfer of the commodity or currency. This will help lay down some basic rules in order to find the true price of that commodity or currency. For this to become successful, additional taxes, duties and levies need to be abolished.

The accumulated wealth of gold in India amounts to more than Rs. 30 lakh crores. The government should try to use these savings for the development of the nation by mobilizing and channelizing the same to productive uses. One efficient use would be to mobillise these savings and efficiently utlilise the same for managing trade deficit.

If the motive is to generate revenues, there are many other ways post the market development. The government could apply an annual fee on foreign bullion players trading in Indian markets and raise revenues through the fees charged on them.
The customs duty collected helps reduces the deficit by a negligible proportion. Hence, the government should focus on implementation of reforms and look at the bigger picture to develop the gold market as it truly possesses the potential of becoming the gold trading capital of the world.

We all agree that these reforms cannot be achieved overnight and implementing them is a gradual process. However, if these small steps towards strengthening the gold market are taken, we will soon become the world leaders in the gold market.

On that note, here's looking forward to a Budget that will truly dazzle.

Chirag Mehta is Fund Manager, Commodities for Quantum Mutual Fund and manages the Quantum Gold Fund ETF and the Quantum Gold Savings Fund among others.


The views expressed in this Article are the personal views of the author Chirag Mehta and not views of Quantum Asset Management Company Private Limited(AMC), Quantum Trustee Company Private Limited (Trustee) and Quantum Mutual Fund (Fund). The AMC, Trustee and the Fund may or may not have the same view and DO not endorse this view.

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