Indian government has imposed a duty of ~11.3% on gold imports. Additionally, they have created bureaucratic complexities, including a requirement from gold importers to export 20% of their imports. The government claims that this has resulted in a serious drop in imports, something they wanted, given consistently high, unsustainable current-account deficits.
As I write this, international spot price of gold is $1,300 per ounce. In India, however, it is trading at a premium of 18%, at a price of $1,534. One might ask who is pocketing this premium. Has import really come to a stand-still? Let me explain the ground realities.
Recently, I arrived in the Indian city of Chennai from Singapore. My bag was missing, which had nothing of commercial value—just my clothes. The airline had me fill out a missing-bag form. When I went to a custom official to get the document signed, he asked me to pay a custom duty on the claimed value of my clothes. He didn’t want to understand that the fact that my bag did not arrive made no difference to whether they were dutiable or not.
Every Indian public servant I have ever met creates a situation to ask for a bribe. The result is that there are all sorts of leakages in any regulatory enforcement. Indeed, most regulations exist for the sole purpose of creating justifications for them to ask for bribes.
Before the 90s, import of gold was heavily regulated and carried massive custom duty. Of course, those days most gold arrived in India through smuggling. A big mafia had built up in Mumbai and Dubai, mostly catering to India’s gold demand. Two things happened as a result: Government lost all prospects of earning revenue from gold imports, and most importantly, smugglers ran a ruthless empire in several Indian cities, particularly in Mumbai, controlling human-trafficking (with horrible consequences for poor girls and children), and financing the real-estate and the film industries. They were the unofficial rulers of Mumbai. When restrictions on gold were eased in early 90s under pressure from IMF, the same smugglers took the shape of what got to be known as terrorists. (All this should not sound strange to those who understand the history of prohibition in the US).
The current restriction and heavy custom duty on gold will repeat the consequences of the era before the 90s. But really in an irrational world where rhetoric has more value, who cares about the real consequences? Indeed, based on my many conversations with traders, all gold that India needs is already coming through smuggling. And smugglers want restrictions on gold imports to stay in place—they haven’t had it this easy for a long time.
Indian government’s restrictions on gold will ultimately—after a gestation period—have only a minor impact on the price. Indeed gold will eventually trade in the Indian market for less than the official landed cost, for smugglers don’t have to pay the hefty custom duty. My guess is that gold will eventually trade at a premium of ~5% over the international price, having already fallen from 24% when the restrictions were imposed to the current 18%. Government will indeed lose whatever revenue it was getting from custom duty. As a secondary consequence, this will destroy wealth by creating more bureaucracy, mafia and terrorism. Most ironically, this will worsen India’s current account deficit, by motivating people to travel abroad merely to bring back gold.
Contrary to what the government claims, gold is easily available in the market, at a very thin, almost non-existent ask-bid spread, a sign of a very liquid gold market.
So while I am not concerned about government’s interference in the gold market, except for its entertainment value, there is something else happening that one must keep an eye on, something that might negatively affect consumption of gold in India.
Indian currency has fallen by 30% over the last three years. Inflation is chronic, currently at ~10%.
Indians desperately need a hedge against inflation. Unfortunately, Indians have very limited options. There are strict limitations on holding foreign currency, let alone foreign properties and investments. Given sustained high inflation and an extremely difficult investment environment within India, Indians invest a very large part of their savings in physical assets (property and precious metals), about 12% of GDP. Indians love gold and will likely do so for a foreseeable future. Moreover, gold has done quite well for Indians—it is currently trading not too far from its highest ever price in the local currency.
Could economic growth reign in on inflation?
India’s GDP per capita is a mere $1,491. Growth rate has fallen to ~4.5%, with the low-hanging fruit now having been picked over the last few high-growth years. Given a very difficult investment environment, it is not easy to invest in wealth-generating businesses. The new generation of Indians coming to the work-force are not trained for the modern economy. Despite that 10 million people join the workforce each year, there has been hardly any increase in absolute net employment over the last five years. What would have been a demographic dividend is rapidly becoming a liability. India is stagnating. Current account deficit today stands at >$80 billion, about 4.9% of GDP.
Could one off devaluation help?
Unfortunately, bad infrastructure, bureaucracy, corruption, lack of industrial training, and lack of rule of law makes India a high-cost economy. India’s problems are structural in nature. Any devaluation will quickly feed back as inflation, after creating a boom and bust cycle in the export-side of the economy. The eventual result is that Indian currency will likely have to be continuously devalued. Most importantly, I see no hope for India to change soon, making it unlikely for it to get back on the path of growth. Even the much publicized anti-corruption movement has mostly been about more free-stuff, and gimmickries of this extra-ordinarily socialistic and hypocritical society.
Even though the falling Rupee will continue to make gold a very good way for Indians to save and hedge against inflation and devaluation, India will likely not be a force for gold to go up going forward in terms of the US dollar. A devaluation of Rupee or increase in international price of gold price will likely require Indians to allocate more of their earnings for gold. But as I show above, there is not much extra cash in India, given its stagnant economy. Any further increase in gold price in the international market will likely result in reduced gold consumption in Indian. Gold needs other markets to pick up the slack.