A 'Golden' Budget? - Outside View by Chirag Mehta

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A 'Golden' Budget?
Jul 3, 2014

With the Modi led government in charge, everybody is hopeful of various reforms that would put India back on the development and growth trajectory. The Gold Industry is no exception, in hoping that reforms are around the corner. The budget is likely the first glance into the policies of the new government and will provide us with cues of the road map for the future. From a policy perspective, the last couple of years have seen many harsh decisions against the interest of various stakeholders of the gold market.

Battling the surging current account deficit problem, the policy makers found gold to be an easy target. Gold being "apolitical" in the Indian context, it was easy to restrict gold imports, the second biggest imported element after crude oil. The result was surging import duties and import restrictions. Rather, a quasi ban on imports was introduced when imports were tied to exports. Rather than using the surging gold consumption as a symptom of growing underlying problems occurred on account of erroneous policymaking, depriving people of a free gold market was considered a viable alternative.

Gold is not the problem but is really a symptom of the problem. Trends in gold consumption and prices tells us too many things about the macroeconomic environment prevailing. Increased gold consumption is a signal of imprudent policies prevailing in a country driving people towards gold consumption. It's not only the social and cultural affection towards gold; this love affair with gold also has strong economic underpinnings.

Unless the government addresses the economic issues that tend to drive people towards gold, discouraging gold consumption by force is really a harsh decision. The idea should be to develop conditions to divert people from gold. The idea of government forcing individuals to choose investment sounds like "Too much Government". When people are combating high inflation, negative real deposit rates and uncertainty in the economy and want to save their money in the form of gold, they should have the opportunity to do so. When the government cannot control the valuation of rupee which seems to go trend southwards with respect to almost all of the acceptable currencies, why should a citizen not hold gold or dollars or Euros instead of rupee or rupee based investments. We live in a democratic society wherein people should have all the rights to deploy their hard earned savings in vehicle of their choice.

This time its different....

People are hopeful that the new finance minister might undo the harsh measures and put the industry back on the track of reforms as envisaged during the previous BJP led government in office from 1999-2004. A verbatim of the budget speeches on gold will help provide the perspective of the government's commitment towards the development of the gold market.

  1. 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

  2. 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
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.

Previous finance minister Mr. P Chidambaram was more adamant in pursuing his deficit targets and thereby ignoring the long run consequences of an interventionist market and negative side effects it brings, smuggling in this case. He put the possible dream of making India the gold-trading capital of world in jeopardy.

Restrictions don't really work...

Historically, while the authorities have pursued policies to de-emphasize gold and to suppress demand for gold, the balance sheet of households showed more gold on the asset side.

In the past, there have been various restrictive policies like the ban on gold imports, the Gold Control Act, which prohibited the ownership of gold partly / completely, ban on forward trading, etc, but all in vain. Even the gold bond schemes met with little success each time they were introduced.

The Committee on Capital Account Convertibility (CCAC) put forward some precise and action-oriented recommendations on the liberalisation of the gold market. The CCAC stressed that it was essential to liberalise the policy on gold while simultaneously taking steps to develop a transparent and well-regulated market in gold, which would be integrated with other financial markets (China is moving in this direction). In its view, the main ingredients of the change in the policy on gold should be:

  1. Removal of restrictions on import and exports of gold,
  2. Development of gold-related financial instruments,
  3. Development of markets for physical and financial gold,
  4. Encouragement of banks and non-banks to participate in the gold market.
The CCAC suggested mobilization of private sector gold for external adjustment and to remove external constraints. There have been half-hearted attempts towards development of the gold market. Removal of tariffs and freeing the market are the prerequisites for this development. There were some efforts made in this direction and now it seems that the previous government reversed all the prior efforts.

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 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.

  • There is a huge amount of accumulated wealth of gold in India. 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 mobilize these savings and efficiently utilize the same for managing trade deficit. It's important to design credible and viable policies for mobilization of these savings like the interest rates offered on gold deposit are so low for anyone to even think about parting away with their gold.

  • 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.

Small steps that can be hoped for in this budget:

  • Sizable reduction in import duty
  • Easing of import restrictions (80:20 rule)
  • Free exports of bullion
  • Encouragement to gold backed financial products like Gold ETFs
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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