Gold imports - The plus and minus of duty hike
By V. Sridhar
The Government of India have recently increased the import duty on gold. The earlier specific rate of Rs 300 per 10 gm has been replaced by an ad-valorem duty of 2%. At the current international price of about Rs 27000 per 10 gm, the new rate translates into a rate of Rs 540 per 10 gm, a whopping increase of 80 per cent of the earlier rate.
Gold is the third major item in the basket of Indian imports, next only to petroleum products and capital goods. The immediate gain of the increase in tariff for gold would be a substantial increase in revenues to the government. By now all agree that, with the revenue collections being sluggish and government expenditure increasing, the deficit is likely to exceed budget figures in this fiscal. Therefore, any source of extra revenue would be most welcome. The increase in tariff is estimated to yield an extra revenue of Rs 600 crores in the remaining part of this fiscal.
The tariff increase would most certainly be passed on to the buyers thus leading to an increase in domestic prices of gold. Will the price increase lead to less sales and hence lesser imports? Studies have indicated that at the global level, the price elasticity of demand for gold is (-)1. That means that if the price goes up by one percent, the demand goes down by one percent. But it must be remembered that apart from the price effect, there is also the income effect or the wealth effect. When an economy does well and people have more income and savings, they tend to buy more gold. Studies have indicated that the income elasticity of demand for gold is (+)2. So if there is an increase by one percent in the growth rate of the economy, the demand for gold would increase by 2 per cent. The immediate effect of a price increase could well be a reduction in demand, but the long term effect would depend on several factors including the economy’s growth rate.
At this moment a reduction in imports would not be a bad thing. The trade deficit has increased this year and the current account deficit is above the comfort level of 3 per cent of GDP. The rupee is under pressure, having depreciated significantly over the past few months. If the tariff increase leads to an immediate fall in imports of gold, it would be a welcome development as that would reduce the trade deficit. Thus if the imports do not fall, there is a substantial revenue gain and if they do fall, the trade deficit gets reduced.
Does this mean that the tariff increase leads to a win-win situation? Is there no negative impact? Not so! There is a possibility of increased smuggling. At the first blush this possibility would appear to be remote. Why would anyone take the risk of smuggling just to avoid a measly tariff of 2 percent? After all there is a cost involved in smuggling. Even if one consignment out of twenty gets caught, the entire gains made earlier would be wiped out. All legitimate questions. It must be remembered that gold is one of the most liquid assets. The economics of gold smuggling is different from other commodities. To take a hypothetical example, suppose a person arranges finance and smuggles gold into the country. The smuggled gold can be sold in cash in next to no time if he has proper contacts in the market, which he would doubtless have. That cash can be used to fund the next consignment of smuggling. Assume that out of the two percent saved, his cost of smuggling (cost of trip abroad, etc) is one percent. His profit margin is one percent. Suppose he organises his affairs in such a manner that he is able to make three trips abroad in a month. That would be a profit of three percent in a month or 36 per cent a year. There are very few businesses that give a net profit of that order.
Remember that India has a history of gold smuggling. There are persons who understand the dynamics of gold trade very well. The old “expertise” is very much there even now. By its fiscal policy, the government should not inadvertently give a fillip to gold smuggling. These are factors the government should keep in mind before contemplating any further tariff increases.
[The author is Director, Institute of Business Laws, Chennai and former Chairman, Central Board of Excise & Customs, India]