Convert India's gold rush into a vibrant industry

By now, India's policymakers are possibly patting themselves on the back for ensuring a slowdown in official gold imports to levels last seen in 2005. They boast that – by imposing an import duty of 10% -- they could (a) reduce the import of gold, and (b) bring the current account deficit (CAD) under control.

But the decline is illusory. It masks gold that got smuggled into India (see table). And it continues, unabated. Smuggling, in turn, has undermined the Indian economy and, specifically, the Indian rupee. Already, hawala premiums have gone up to 4%.

More serious is the possibility of gold smuggling attracting large smuggling syndicates, which could lead to the creation of a well-stocked and well-oiled pipeline. When such a pipeline is established, it is difficult to shut it down. Thus, even if the government were to restore duty-free import of gold, this pipeline will be used to smuggle in narcotics or, worse, even arms. Such a situation should be avoided.

Recent pronouncements by the government indicate that it is now willing to ease gold import duties. But removing import duty altogether could be a big mistake. The turbulent economic climate in India, and the world, could cause a surge in gold import again, compelling the government to re-impose high import duty rates. Such an on-gain-off-again policy is not desirable, either for the trade or for governance.

One way out would be to marginally ease import duty to say 8%. But the government should allow gold to be made available from designated domestic banks by paying a surcharge of under 4% of the prevailing market price. That would reduce smuggling, since 4% is lower than 8%. Moreover, banks could now encourage a healthy domestic gold market.

To make this happen, the government would have to introduce a variant of the Turkish model. The government could allow designated banks to invite domestic gold deposits in the form of biscuits, bars and coins. If temple managements agree, gold lying with them could be melted, recast into bars or biscuits, certified, and deposited with banks. After all, India has a huge horde of over 25,000 tonne investment gold with individuals and with temples.

For every tonne of gold deposit that the banks garner, the government could allow them to import duty-free a percentage of the gold deposits. In many ways, this would be similar to the REPs (Replenishment Export Permits) that the government had introduced in the late 1980s to spur exports and earn desperately needed foreign exchange. Except this time, it would be a gold-for-gold scheme.

The banks could then offer this gold to the trade after levying a surcharge of under 4%. The banks would enjoy a spread, which could be used to pay a 1% interest annually to gold depositors. And the trade could benefit as it could get gold readily from Indian banks at half the import duty. Considering that India consumes almost 700 tonne of jewellery annually, the trade will need this gold at low duty rates.

But such a strategy can succeed only if the gold trade is also involved. For instance, registered gold dealers and refiners could be given a small (0.5%) incentive for bringing gold deposits to the bank. Refiners could be partners with the bank to certify the quality of gold biscuits and bars (as counterfeit gold sometimes comes in through import channels too).

This would reduce smuggling. Banks could draw out the gold stashed away in vaults and lockers to facilitate economic growth. The trade, the government, the banks and the customers would all benefit. It must be remembered that India's gold jewellery trade is larger than the country's entire FMCG trade on an annual basis, and employs around 3.5 crore people. And the gold industry could even look at the export market if the gold supply and export gets liberalised.
It would reinforce the old principle – that any policy which makes all segments benefit is a better one than one which makes only the government earn.