On the heels of boosting import fees on gold to 8% (quadruple the tax two years ago), Indian Minister of Finance P. Chidambaram said further increases were not planned. “I don’t want to become too unpopular,” he told reporters.
At the same news conference, he begged his fellow citizens to refrain from buying gold for one year, to gain control over the nation’s spiraling current accounts deficit. The Indian CAD is stifling the economy and the rupee. Mr. Chidambaram noted that gold imports had dropped noticeably in the weeks after the tax hike:
“Net gold imports, averaged USD 135 million a day, in first 13 business day in May till May 20. However, in the subsequent 14 business days, it averaged only USD 36 million, so gold imports have sharply come down. But I would be happy if they come down even further,” he said.
Some analysts attribute the drop in imports more to the falling rupee than to the extra 2% import tax. Others note that higher taxes only fuel a rampant gold smuggling market. Thomson Reuters GFMS estimated 102 tonnes of gold was successfully smuggled into India last year, and projects that this could increase as much as 40% this year, to 140 tonnes.
As the government pressures banks to no longer sell gold on consignment to jewelers and restricts who can import gold even further, smuggling is expected to increase over current record-breaking levels. Gold is used as a store of wealth for most of India’s 1.2 billion people, as only an estimated 6% of villages have a banking branch. (36,000 of 650,000 villages.) Therefore, gold chains, bars and coins are the only way for most Indians to store their money.
Inflation, which has been 10% or more recently, is also a real concern in India. Even Indians in larger cities that have access to banks prefer to buy gold instead of letting their rupees sit and lose money. People will find ways around the gold import restrictions, which will mean that official physical gold demand numbers may drop, and the government will lose out on tax revenue while dollars accumulate in the underground economy.