Saturday, January 5, 2013

Shooting the messenger - India's Gold imports (Part I)


On 5th April 1933, citing difficult economic conditions, the then U.S. President Franklin Roosevelt signed a decree. The Executive Order 6102, as it was called, made it illegal for American citizens to possess gold (with certain exemptions). The Order specified a date, 1st May 1933 to be precise, before which all citizens were required to deposit all the gold bullion held by them with the U.S. Treasury or face heavy penalties and / or imprisonment upto 10 years. The U.S. Government would pay $ 20.67 per oz (troy ounce, i.e. 31.10 grams, the then official gold exchange rate) for the gold, the Order said.

A few months after the Order, the President signed The Gold Reserve Act of 30th January 1934, outlawing private possession of Gold and suddenly changing the price of gold to $ 35 an ounce. In effect, wealthy Americans, who had amassed huge amounts of gold over generations of hard work and entrepreneurship since the onset of American industrialization in the mid-nineteenth century were short cheated for millions of dollars by the government in the name of saving the country. Mind you, financial markets were not as well developed in those days as they are today, and gold was one of the primary means of wealth accumulation in the U.S. at that time.


“Steps were being taken to control the Current Account Deficit…there was a need to control gold imports…” said India’s Finance Minister Mr. P. Chidambaram at a meeting of the National Development Council on 27th December 2012. "We are worried about gold imports. It is an unproductive instrument", Mr. Raghuram Rajan, Chief Economic Advisor to the Government of India had said earlier. 

Over the last few months, there has been a sustained campaign in the press about India’s ‘soaring’ gold imports. The government has raised taxes dramatically on gold, quadrupling the import duty rate, changing it  from specific to ad valorem, and doubling the excise duty on jewellery as well. “One of the primary drivers of the current-account deficit has been the growth of almost 50 percent in imports of gold and other precious metals in the first three quarters of this year,”  Mr. Pranab Mukherjee, the then Finance Minister had said earlier last year, before announcing the tax hikes. “I have been advised to strengthen the steps already taken to check this trend.” To cut a long story short, Indians are buying too much Gold, and that is causing problems in managing the economy, we are being repeatedly told.

It is therefore time to take a look at the numbers and check out the facts. Take a look at the data on gold imports given in figure 1 below:

Fig. 1: Ninety percent of India's imports are non Gold

 We observe that:

1. Gold imports were 9.26 % of India’s total imports in 2011-12. Ninety percent of India's imports are other than gold.
2. Imports were in the 5 – 6 % range till 2008-09 but increased after that, roughly the time when the rapid deterioration of the economy began.
3. There has been a dramatic increase in the price of gold in the last decade. Increase in the quantity of gold imported therefore, is more benign. (It is in the range of 7 - 8 % per annum)

Gold imports have thus increased only in line with the overall growth of the economy, with only a small uptick in the last 2-3 years. They are in fact expected to come down in the current year and the next. The brouhaha around gold imports therefore does not seem justified.

Don’t they cite some data whenever they blame gold imports?

Figure 2: India's CAD started deteriorating from 2004-05 itself
Most of the time, it is pointed out that gold imports are high as a percentage of Current Account Deficit (CAD, the excess of total imports to total exports). Read the Finance Minister's comment yesterday: ‎“Suppose gold imports had been one half of the actual level that would have meant that our ‎foreign exchange reserves would have increased by $10.5 billion,” Chidambaram said. “I would ‎therefore appeal to people to moderate the demand for gold, which leads to large imports of ‎gold.”  But this is a wrong metric to use, since it does not prove causation. As  Figure 2 shows, India’s current account started deteriorating as far back as 2004-05 itself, much before gold imports picked up. Current account deficit is caused not just by gold imports, but by all imports and all exports. The question is not why gold imports are rising, but why the CAD is rising. Contribution of gold imports to current account deficit is much smaller than what is made out to be.  In 2011-12, India's total imports were USD 607.158 billion and total exports were USD 529.003 billion. Gold imports were thus only 4.95 % of the total Foreign Trade of USD 1,136.161 billion, a very small portion, compared to other imports like petroleum or defence. Overall current account deficit on the other hand, has increased at 64 % p.a. in the last 7 years. 
But, aren't gold imports, however small, a waste of money? After all, gold has no intrinsic value.

We will look at these and other arguments in the next part of the article. 

(To be continued)

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