Debasing gold

As surging imports threaten our fiscal health, time to make holding the yellow metal costly



By Mohan Sule


Among the many shocking statements made by the finance minister during the recent budget speech was the revelation that gold imports surged 50% last fiscal, contributing in no small measure to the current-account deficit. Gold imports totalled US$ 60 billion as against US$ 150 billion of crude oil imports in 2011-12. The current-account deficit widened nearly 38% in April-December 2011. As ornaments constitute just 15% of our exports, it is obvious that most of the imports are used for domestic consumption. Yet the budget’s proposals to double customs duty on 99.5% purity gold to 4% and excise on refined gold to 3% to cool down purchases have been met with stiff resistance from jewellers. The finance minister has not only promised a review but has allowed Titan Industries to bring in gold directly instead of routing it through MMTC, the canalizing agency responsible for nearly 25% of India’s gold imports. Thus, there does not seem to be any serious application to discourage local buying. Of late, the yellow metal is being increasingly viewed as an investment option, particularly after the collapse of Lehman Brothers, when investors’ confidence in the dollar got shaken. Also, the quantitative easing that followed the credit-crunch crisis fuelled inflation, depreciating currencies and pushing investors to aggressively corner gold. No wonder gold has appreciated 100% in the three years from September 2008 and nearly 35% in the last fiscal. Capitalising on the fear of an uncertain future are gold exchange traded funds. These schemes have returned around 29% as against the Sensex’s loss of 10.77% in the year to 20 April 2012. Lending institutions are contributing to the gold rush by allowing jewellery as collaterral.

Consequently, gold’s role as a hedge against inflation and a safety net in volatile times is becoming more pronounced. At the same time, the increasing demand is threatening the health of the nation. Money that can be effectively used by the capital market to create liquid wealth and employment opportunities is getting locked in an unproductive asset. It is time to declare a fiscal emergency and tackle this problem head-on. What can be done? The cap on baggage gold was relaxed in 2006. Passengers can sail through 10,000 gm of gold once in six months by paying just Rs 250 per 10 gm. The easy availability has made smuggling unremenurative but not dimmed gold’s luster. On the contrary, consumption has increased as the global economic turmoil has necessitated diversification of portfolio. A radical solution would be to allow duty-free imports. In the short term, there will be spike in landed gold. To stem the outflow of foreign currency, an export commitment of equivalent or double the value of imports could be imposed. The proposal would not only be exchange-neutral but also give rise to a vibrant secondary market for gold credits, boosting export-oriented units’ revenue. This would be similar to polluting companies buying carbon credits from those employing clean technologies. Other measures could include the government buying back gold and issuing tax-free bonds at a coupon 1%-2% below prevailing government security yields. This, however, would open a channel to bring black money into the mainstream.

Postponing income tax on the proceeds of gold sale if they are locked in infrastructure bonds could be a boon to the government. This would be a slight variation on the scheme of diverting the proceeds of long-term gains earned on property held for more than three years into bonds of the NHAI or REC. The cost of buying and holding gold could be made expensive by including the value of gold, which could be the average of the high and low price during the fiscal, held for more than three years in the income. Right now gold and jewellery are clubbed with property and car for attracting wealth tax up to 2% at the highest slab if the value of all these assets is more than Rs 30 lakh. Gold and accessories in excess of 500 gm could be separated for levy of an independent gold-holding tax at the same rate. Doing away with gold exchange traded funds should also be considered seriously as they too are responsible for fuelling gold prices. Even loans against gold should be given at stiff interest rates. A weapon of last resort should be bouts of gold selling by the Reserve Bank of India to ease the demand-supply gap and calm domestic prices. Unfortunately, with China emerging as a major buyer, gold is attracting more attention. The US slowdown and euro-zone recession, too, are enhancing its allure. Nonetheless, it is important to realise that gold is not invincible. Investors who bought into the real estate bubble in the US realised this at a great cost to them and the global economy. To avert another meltdown, it is necessary that governments and central banks around the world undertake periodic debasing of gold.

Mohan Sule

A cruel joke

The finance minister relies on increase in taxes to narrow the fiscal deficit instead of a buoyant economy to boost revenue

By Mohan Sule

Countries respond to slowdown in two ways. The government reduces direct and indirect taxes and the central bank eases liquidity and interest rates. This was what happened after the credit-crunch contagion spread around the world following the collapse of Lehman Brothers in September 2008. These short-term fiscal and monetary measures boost sentiment as the environment allows resumption of risk-taking. How has the budget for 2012-13 fared when measured against these parameters? The finance minister’s challenge was to accelerate growth and at the same time be mindful of inflation. To kickstart the economy, he could have used the budget to roll out a second fiscal stimulus by offering still deeper excise and import duty cuts after those announced in 2009. The resultant expansion in economic activity could have boosted revenue, taking care of fiscal deficit. On the other side, he needed to cap if not trim social spending to tame inflation. Though the allocation to the resource-guzzling rural employment guarantee scheme has been scaled down, there is the food security bill waiting in the wings, Excise and service tax have been revised up 2% points and income tax slabs altered to bring marginal relief. Individual taxpayers will now have to wait for the Direct Taxes Code to kick in for deeper cuts. The is necessary to balance out the higher indirect levies incorporated in the imminent goods and services tax. The desperation in relying on revenue from higher taxes rather than from a buoyant economy is against the backdrop of fiscal deficit climbing upto 5.9% of GDP instead of the budgeted 4.6% in 2011-12.

The twin effect would boost prices of goods and services without a corresponding increase in the purchasing power of consumers, affecting private consumption: hardly the ingredients to revive the growth story. On the other hand, the finance minister kept all pending reforms, which could have attracted capital, created jobs and gone to meet growing demand, outside the purview of the budgetary provisions, mindful of the mercurial allies of the UPA government. A cruel joke, indeed. By doing so, the government has sent out the message that India has reverted to the pre-reforms era, which penalized the rich by higher taxes and viewed foreign investment with suspicion. Instead of lifting more population into the middle class by expanding the market, the government is content in giving subsidised food and fuels. In fact, non-plan expenditure is higher by 8.7% in the current fiscal over the revised estimate of last year mainly on account of subsidies, which would push up government borrowings and put pressure on interest rates, thereby triggering inflation. In a way, inflation could be good for the government. This would increase the nominal value of the GDP and, importantly, erode the debt burden. In fact, some apologists are already patting the UPA government for bringing down the debt to GDP ratio to 50.1 in 2011-12 as against 61.5 in 2004-05, when the first Congress-led coalition government was formed.

Similarly, the move to double the issuance of infrastructure bonds to Rs 60000 crore is a clever way for the government to take on off-balance-sheet debt just as the oil bonds that it issues to PSU refiners to partially compensate their underrecoveries. This will keep its interest payment to GDP ratio down despite higher borrowings from the market. The tax-free status gives these bonds a captive audience. A better way would have been to entice investors to the infrastructure sector by encouraging the mostly PSU issuers to become competitive, introducing transparency in the awarding of projects instead of favoring PSUs, clearing orders and payment quickly, removing restrictions on borrowers’ pricing of their products and services, and plugging leakages of allocations to public utilities. The inability to let go control of PSUs, resulting in increasing impatience of foreign institutional investors, and also the fear that the inflationary proposals in the budget could dim the attraction of equity markets have no doubt contributed to scaling down the divestment target by Rs 10000 crore for the current fiscal. Not that the finance minister has not realised the importance of a vibrant equity market to raise resources. The 50% tax deduction for investment up to Rs 50000 for first-time investors with income below Rs 10 lakh per annum under the Rajiv Gandhi Equity Savings Scheme underscores the government’s acknowledgement. This will create a ready receptacle for PSU share sale. Crucially, it gives investors control over their stock picks instead of relying on fund managers like in the equity-linked savings schemes. What could be a stronger indictment of the mutual fund industry’s failure to live up to the expectation of the small investors?

Mohan Sule