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2014

Economy Updates – Gold Economy – Apr-2014

Gold Economy

If for one year there are no gold imports, it will change the current account deficit story of the country. Indians think they are buying gold in rupees. Actually they are buying gold in dollars.
- Finance Minister P. Chidambaram.

  • The Finance Minister of any country aims to have positive current account balance.
  • However, in India Gold has remained one of the chief contributors to current account deficit.
  • India imports three things mainly
    • Crude Oil
    • Cooking Oil
    • Gold
    • The first two are essentials.
    • Gold is considered to be Non-essential.
  • Further, apart from constant increase in gold imports, rising price of the gold and weakening of the rupee has added more fuel to the ever increasing current account deficit.
  • So our Government wants to reduce the import of Gold.

Impact of Gold on Indian Economy

1. Current Account Deficit

  • The first major problem the Indian economy faces with this high gold consumption is the increasing Current Account Deficit (CAD).
  • Indian has to pay for its gold imports using its foreign exchange reserves.
  • Foreign exchange reserves hold a key especially among the developing countries.
  • If we have Current Account Deficit, we need to use our Forex reserves to settle and in the process, we deplete the Forex reserves.
  • If it continues, in the long run we might not have money to get imports.
    (FYI: Current Account Deficit: A measurement of a country’s trade in which the value of the goods and services it imports exceeds the value of the goods and services it exports)

2. Weakens Domestic Currency

  • Growing trade deficit leads to weakening of domestic currency.
  • For India, The weakening of domestic currency results in loosing trust of the people in rupees, and foreign funds out of India.
  • That, in turn, means less investment and slower growth, and thus a further weakening rupee.
  • In leading American journal it was quoted that
    Indians are so gold crazy they’re sacrificing their currency and their country’s economy in the bargain.

3. Deprive financial Markets of Funds

  • Investments in the physical form of gold are either stored in bank lockers or get exchanged for making jewellery.
  • It seldom gets traded for money.
  • Imagine the same amount being invested in the capital markets.
  • It allows the companies to raise capital in the form of debt or equity and expand their business.

4. An Unproductive Investment

  • Billions of dollars worth of gold sitting idle in family vaults.
  • Such a large amount can make a huge difference to the productive capacity of the economy.
  • It not only just adds to the physical goods produced, it also has a potential to improve employment in a vastly populated country like India.

5. Dead Investment

  • Gold isn’t a stock or a bond. It offers no income, no dividend, no earnings.
  • It is worth only what people are willing to pay.
  • People do not sell gold because it is long term investment but the same is the case with equity or property markets which unlike gold gives dividend or rental income also.
  • Further, many experts say a rise in gold prices is unlikely without a big slump in the US stock market or in the value of the dollar, neither of which seems likely.

Steps taken by the Government to reduce Gold imports

  1. The Government raised the gold import duty by 2% to 6% in January 2013, then in June 2013 increased to 8% and then again increased to 10% in August, 2013.
  2. The Government also increased duty on raw gold to 5%.
  3. The Reserve bank of India (RBI) announced to introduce three or four gold-linked products in short time.
  4. The Government also introduced transaction tax of 0.01% on non- agricultural futures contracts, including for precious metals.
  5. Government enforced the “Pareto Principle”, i.e 80/20 rule in July, making it mandatory to export a fifth of all gold imports. Under that rule, only six banks and three state-run trading agencies that had facilitated export of gold or jewellery in the past three years were allowed to import.
  6. Government banned imports of coins and medallions.

Impact of the steps taken by the Government

  1. The official figures are not out yet, but it is believed that India’s gold import in year 2013-14 were around 800-850 tonnes, i.e. lower than last year’s 950 tonnes.
  2. Current account deficit is thus likely to be $35 billion in the 2013-14, much lower than about $88 billion recorded in the previous year. Decline in gold imports by $20 billion could be the main reason for reduction in the current account deficit.
  3. However as we read in newspapers, smuggling of gold has significantly increased. Let’s see how the next government plans to keep a check on the same in the future.

Gold is going up because people are buying it, and people are buying it because it’s going up.

Financial Management