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Gold is Not The Problem: Lack of Exports Is

The Government has, in its attempt to control gold imports, increased duty on Gold imports to 8%. All this does is increases the price of Gold in rupees, giving people like me who are long on Gold an even bigger reason to buy gold. Remember, Gold is not a consumption good, it is an investment – and if you want to stop a bubble in it, you do not increase its price.

Read: Raising Gold Duty Will Only Increase Gold Demand

In April 2013, when there was a Gold “Crash” in the world markets, India promptly doubled Gold imports – in fact, they were up by 138%.

The RBI has been getting in on the act too. They have recently tried to reduce the leverage in Gold imports, by making it possible to import only against 100% payment, versus giving credit on a “consignment” that was the norm earlier. Importers who would use the credit period to sell the gold and then pay off the banks will now have to front-end their payments or pretend to import something else such as diamonds and push through Gold instead. While this move will constrain gold imports, it may also help protect against defaults in the jewellery industry like the 7,000 crore Winsome Diamond default

The sliding rupee.

The Rupee-USD rate is nearly at Rs. 57 today (and has crossed it intraday).


The all time high is 57.21, breaking which would make things very complicated. A rising dollar makes loans in dollars (that many corporates have taken) dearer to return. It increases inflation since it will hurt the price of crude, which is our biggest import. And that of gold.

However, we have to understand that Gold isn’t the problem. India is the world’s biggest importer of gold, and this has been the situation for a very long time.

Will Not Stop Importing Gold

Indians trust gold, they give it to their children in weddings, they think of it as financial security. While some of it is steeped in tradition, the feeling of gold-as-secure is also from the fundamental quality of Gold – as something that has limited supply, can be carried around and broken down into smaller quantities (great for use as a currency, versus say real estate), and won’t depreciate over time. And then, it’s one of those things that people love to have as jewellery and flaunt it.

Then why isn’t gold popular in the rest of the world similarly? India has seen way too much inflation, and distrusts the banking system. The inflation is because of many factors, but the biggest one in my opinion is that the RBI prints too much money. We have printed money to the extent of 15% per year, since 1997.

When you see paper currency devaluing itself so much, and visibly so with inflation, you will surely cut your dependence on it.

Attempting to curb this demand which is “structural” through duty hikes or leverage cuts is not going to help.

The Three Prong Solution

1) Fix the money supply growth problem. Bring inflation down to zero or negative and shore up the rupee by selling dollars (we shouldn’t have this many dollars on the RBI balance sheet). Soak up liquidity. This will cause a recession. And that’s okay because where we’re going today, we will see a huge depression instead.

2) Help India become competitive. This means you have to “give” resources to the private sector for free or cheap. Like 3G airwaves. Like radio spectrum. Like making export procedural hassles next to zero, including at ports. Like fixing our roads and ports, making most airports private. To raise funds to do so, we should sell all public holding in banks, infra companies like BHEL and ONGC, even at low prices.

India doesn’t need just competitive exports – we need Indian companies to compete with foreign players better, even within India.

(Do not do stupid things like make exports tax free. If you want to reduce taxes reduce it on all companies, not just exports.)

3) Increase the financial strength of the rupee. Let foreigners buy our debt. And equity. Let there be free trade of the rupee. Attempt to buy oil in rupees and persuade oil rich nations in the gulf to keep rupees on their balance sheet.

This is a 10 year solution, but we have elections next year, so none of this will happen, unfortunately. In the interim, I would bet on gold to strengthen (in rupees) and the rupee to weaken. We could quite as easily go to 60.

  • PrAvEen says:

    When ppl are ready to buy @ 32k, they will obviously happy to buy @26k., how the govt thought this 8% duty will reduce it. It will only help the smuggling economy.

  • vivek says:

    where there is demand and mispricing it will be filled ..Many Haji Mastan’s will rise again.

  • Dheeraj says:

    Chidambaram may be cribbing about gold today.
    But, if you go back in time – the impetus to the rally in gold prices worldwide, which in turn has fuelled the demand for gold, was actually provided by India when we (RBI) decided to buy 200 tonnes of the yellow metal from IMF in late 2009.
    RBI spent $6.7 b to buy that gold and shore up reserves, and others jumped in fueling the rally. Of course this helped keep our reserves healthy and the mandarins at RBI were praised for taking a market savvy investment decision. Nobody cribbed then. Now that we have a weak economy (primarily contributed by misguided policies) and the demand for gold hasn’t satiated, we see it as a problem.
    When others want in, we crib. Talk about hypocrisy.
    More than a problem, it is actually a symptom that people have lost faith in the economy and thus feel the need to hoard something for that rainy day.
    Our finance minister is behaving like a quack who treats a “symptom of a problem” as “the problem” itself.
    I have a simple advice for him. You focus on the economy – this gold problem will take care of itself.

  • Adheer says:

    Excellent article.
    Regarding #1 (RBI selling dollars), RBI needs to hold dollars to make payments (interest and principal) on sovereign loans, and imports. Typically holding 1 month worth of trade deficit in dollars is a safe practice. Having low dollar reserves would be risky.
    Although I am proponent of free markets and making the rupee fully convertible, I have doubts if it will work in India’s favor.
    a) Why not increase the VAT on gold to 5%. Here is Maharashtra, the VAT on purchasing property – which is typically once in a life-time decision for majority is 5%. There already is VAT on steel, cement and other raw materials used in construction of buildings – which is NOT offset against the VAT charged on the final sale of the property.
    So why not apply VAT on gold ?
    b) We have mismanaged our currency so it would be hard to convince oil rich gulf nations to keep rupees on their balance sheet. Every since independence, our currency has consistently depreciated.
    So why would someone want to keep a depreciating currency on their balance sheet ?
    c) Reduce service tax by 1% every year (if not more). Service tax in the range of 5-7% is more appropriate. The best thing to stimulate the economy is to reduce taxes.
    d) Eliminate extortionist tax regime that breeds corruption. For example, in Mumbai, the BMC charges 41.5% of rental income as property tax. Unfortunately not many people are aware about it. This only breeds corruption and pushes inflation.
    e) The Food Security Bill is the biggest “known unknown”. Given the current state of the PDS and our rich legacy of scams, I feel a mismanaged FSB will take the USD/INR in above 80 and create all sorts of shortages and panic.
    Through FSB, the GoI aims to procure 80 million tonnes (MT) of food grains every year, when the best they have done is 40-45 MT. This is a logistical disaster waiting to happen.

  • IsItPossible says:

    I replied to one of your earlier post that watch rupee rise to 65+ or even 70 in a year or two…
    What you suggested above “Soak up liquidity” is very appealing and may even sound logical but lets understand the impact and sever dire economic crisis this will cause…
    For a moment lets imagine our economy goes into a recession:-
    India has NOT seen a severe recession (like one in euro-zone today or US 2002/2008) in almost two decades, hence the young population (age group 25-40) does not have a clue of what that really means.
    Effects of any recession:
    1. Massive loss of jobs
    2. Economic contraction causing companies to put hiring freezes
    3. Typically recession happens after a massive blowout in a particular industry bubble which in turn means massive loss of money in that particular industry
    4. Depressed stock market causing massive loss of wealth
    5. Mostly affected population is middle class and upper middle class (which happens to be a HUGE number in India)
    Side effects:
    1. Political play grounds – Politicians exploiting situation for their benefits
    2. Massive unemployment led to civil unrest and destruction of public property
    3. Social stigma as family goes through a hard financial times
    4. Overall very difficult time for the masses
    BUT how can a growing economy go into a recession?
    1. As mentioned in above article “RBI Soak up liquidity”
    2. Euro-zone collapse (a very real scenario)
    3. Housing bubble crash – this can happen anytime as soon as 1 or 2 above starts
    4. Any other reason BIG enough to shift the entire national economy downwards including scandals
    In short, times ahead are NOT so encouraging and one shall make wise decisions …

  • Bunker Guide says:

    See the fifth graph on the below link…
    The fifth graph shows that in year 2015, India might see a bottom of our stock index fairly reaching 13800 levels..the author is a wave theory analyst and is trying to replicate wave motions by taking reference from 1988 to 2008. Consumption of cars within India is slowing down since last 5 months. Exports are dwindling and whatever exports are happening govt wants those exporters to benefit more(maybe for donations).
    Now before we see a bottom in 2015 as per author, index will need to peak out and break the 21206 level of Jan 2008. This can easily happen in Jan or May-2014. Remember, India elections are in April-May 2014. Also, look at the sixth graph which says most peaks in Indian indexes have occurred in January and in the first 15 days. One peak in Indian index came in May-2006 and that was also in first 15 days of May.

  • Reema says:

    Rupee is declining against US dollar. But govt. won’t allow people to hold US dollar to hedge against Rupee. Same thing with the gold. But nobody is complaining about dollar restriction.

  • ActiveInvestor says:

    you don’t just keep buying something you don’t produce , I don’t really care the more Indians buy gold, the more expensive everything will get for them, including fuel, gas, veggies ,transport, plastics , almost everything … since transport costs are everywhere .
    Also Indian markets will rise to new highs in the next year and year after ….Global thingy