Gold is in the news again, and how! Of all the people who could have publicly called for easing of gold imports, Sonia Gandhi, or as some news reports say, the National Advisory Council that she heads, must be the least likely. Equally unlikely is the news--although one can hardly believe it--that the Finance Minister has rejected Mrs Gandhi's request. Of course, I'm no expert on Delhi's byzantine politics so I have no idea what happens next--but I guess neither NAC members nor Mrs Gandhi are likely to sit on dharna outside Rail Bhawan to press for their demands.
However, the fact remains that the restrictions and duties on gold imports have created a number of distortions. One curious effect--which I'd mentioned in this column a couple of months ago--is the disconnect between the NAVs of gold funds and gold ETFs and the market prices of gold ETFs. As I'd written at the time, this is a strange by-product of the upheaval in gold import duty and rules, in combination with the way gold funds are run and valued. It so happens that ever since the government raised the customs duty on gold and constricted its supply, gold ETFs have started trading on the markets at a significant premium to their NAV. Depending on supply and demand, there's always a little difference between the market price and the underlying NAV of any ETF. However, since August, as GoI has started squeezing gold imports, there was a steadily increasing premium which eventually reached about 10 per cent for all gold ETFs.
Of course, distortions for investors in gold funds are only one aspect of the gold problem. According to reports, the NAC/Sonia Gandhi letter was specifically about the 80/20 rule that was brought in last year. Under this rule, gold importers must export 80 per cent of the value of what they import. The real problem seems to be that gold curbs is the effect of the rise in smuggling. This has created a situation whereby those who are in any gold-related business are at a commercial disadvantage if they operate with legally imported gold. Those who are willing and capable of dealing with smuggled gold can compete unfairly with those who can't. This is typical of the perverse incentives that such controls create.
At this stage, the government can't let the smuggling issue get in the way of tackling the current account deficit, but the downstream non-financial effects are considerable. The money and the expertise that criminals build has many collateral effects. Arguably, the whole of the Mumbai underworld was a creation of years of smuggling during the 70s and 80s. While the time scale over which gold smuggling happened earlier was much longer, the value is likely to scores of times higher now.
And then there's the spillover effect on the economies of other countries. Gold that is smuggled into India is first imported into other countries. Last year, Sri Lanka found its gold imports shooting up and its CAD worsening. It imposed heavy duties (up to a 100 per cent for some time!) and other restrictions to prevent it from being used as a smuggling conduit. When Sri Lanka tightened up, most of the action shifted to Pakistan. Last week, Pakistan placed a blanket 30-day ban on all gold imports, citing pressure on its currency. Incidentally, while announcing these bans and restrictions, both countries explicitly mentioned India's gold duties as the root cause of their troubles.
At the end of the day, it should be pretty clear to everyone that emergency measures apart, its worse than useless to try and stop gold from finding its way into India. The gold will flow in anyway, so it makes more sense to avoid all the other harmful side effects caused by it sneaking in through the cracks. Some day, Indians will get sensible about gold, maybe. But don't wait around for it.
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