UPA chairperson Sonia Gandhi has reportedly urged the Central government to relax import duties on gold. The finance minister has, however, stated that there are no plans to relax these duties until the current account deficit comes down to a manageable level. As these columns have long argued, problems such as the rising CAD need to be solved through long-term structural readjustments. Short-term measures, such as raising import duties in response to a rising CAD, amount to financial repression and can have unexpected consequences for the economy.
The finance ministry has sharply hiked import duties on gold over the last year (from 2 to 10 per cent), most notably last July-August, to fight the rapidly depreciating rupee. These steps have not taken into account the reasons for the spurt in the demand for gold, namely a loss of confidence in other investment alternatives for households and the use of gold as a hedge against high inflation. While the curbs on gold may have helped contain the rising CAD, they have led to other egregious outcomes for the economy. One, there are multiple reports of a rise in gold smuggling. Neighbouring countries such as Pakistan have seen large-scale gold imports, suggesting that these are then being smuggled into India. A chain of illegality grows around such transactions that encourage the use of black money and hawala. Two, it has set back Indian jewelry manufacturers, who have to import gold at a much higher price than before. The controls and duties on gold reduce the competitiveness of Indian exporters.
The battle to save the CAD, therefore, has led to the incentivisation of illegal activities such as smuggling and hurt the competitiveness of the jewellery manufacturing sector, while the structural issues that caused households to rush towards gold as an investment choice have not been solved. Inflation remains stubbornly high. The use of such instruments of financial repression sends out a disquieting signal to the outside world: that the Indian government prefers to use techniques of repression to make its account books look good, and is unable to address the root causes of the lack of financial inclusion and high inflation. It is, therefore, high time for the curbs on import of gold to go.