Whichever way you look at it, the customs duty hike is good
Jan 22 2013, 2135
After sending out advance signals on raising the import duty on gold, the finance ministry finally bit the bullet, raising duty by 200 basis points. That it did so even without waiting for the budget and at a time when the finance minister is hosting investment road shows abroad, is clear sign that the government means business. Rising gold imports in the past two years have been blamed for the high current account deficit (CAD). After oil, gold imports have depleted our foreign exchange most, raising demands on the government to arrest this unsatiated demand. No wonder then, the government has taken the simplest of measures by resorting to duty hike in the hope that this would be passed on to both consumers and investors alike, leading to a possible fall in consumption. On the other hand, voices have also been raised that given the everlasting desire and lust for owning and hoarding gold among Indians, it is highly unlikely that the duty hike will lead to significant fall in consumption. These sections argue that any hike in the cost will adversely impact savings in the long term, when gold is probably the only asset class that has given protection against inflation in the past five years. This is a rare situation where both the economic arguments are correct, and advocates for and against the duty hike can claim that the other has been seeing the glass half full. We are of the opinion that those who believe that hiking import duty is a worthless exercise are correct. It will have no or marginal impact on demand and imports are unlikely to drop. The higher the price of an asset, the more people want to own it. Should that be the case, we would also like to believe that the government is right in increasing the import duty. When you cannot change a negative situation, the very least you can do is derive maximum benefit out of such adversity. With the hike in import duty, at least the government would get more revenue compared with what it has been earning so far. This is cause for solace. Also, with gold attracting huge amounts of investments in black money, a higher duty should help the government to at least indirectly tax the untaxed. Though collections would be miniscule on an overall basis, it is still better to get something than nothing at all. Fears that higher import duties would lead to greater duty evasion are overstated. Volatility in the currency market has made it unattractive for smart investors to book profits by evading duty on gold imports. Another fundamental change in the bullion market, which should make the duty hike more effective over the medium term, is with regard to paperless trading in the metal, where a huge amount of speculative money has found its way as short-term investment, contributing to surging imports. This should shrink when gold prices turn volatile and the import duty begins to pinch, helping the government achieve its purpose of curbing imports. As for the ballooning current account deficit, the government’s decision to allow oil companies hike diesel prices every month will finally help it tackle the problem. The rupee has already appreciated against the dollar and other major currencies within a few days of changing the pricing regime. While CAD is not going to come down overnight, a stronger currency will certainly help the government set its house in order in the medium term.