Gold analyst SANJIV AROLE does a deep dive into the repercussions of the crippling hike in the gold import duty to 12.5%, which comes at a time when the gem and jewellery industry is besieged with its own set of challenges. Here are his expert views.
It is often said that ‘politics makes strange bedfellows’. In spite of that, no one could have envisaged that the fortunes of the Indian cricket team at the World Cup and that of gold in recent times would be so strikingly similar. India’s performance was true to form as the team sailed into the semi-finals of the mega event on the back of some very impressive wins and barring a few hiccups (the loss to England, a washout game, etc.).
All seemed hunky-dory and India seemed destined to win another cricket World Cup after 1983 and 2011. Likewise, since the 2018 Union Budget, gold seemed on the right path. The then finance minister proclaimed that gold would be treated as a financial asset. There were indications that the government would adequately tweak the gold monetisation scheme, the gold coin, the gold sovereign bond, et al.
The then incumbent commerce minister also set into motion the formation of the Gems & Jewellery Domestic Council. A new gold policy was waiting to be unveiled, a gold exchange, gold bank, etc. were all on the anvil. There were even enough indications that the vexed import duty on gold would be reduced to reasonable levels (4% duty was being bandied about). The nightmare of excise duty and introduction of GST was a thing of the past.
The industry seemed to be eagerly awaiting the next phase of making the gold market more open, transparent and mature. The Union Budget was awaited with bated breath, particularly as the new finance minister, as commerce minister, had always encouraged and supported the gems and jewellery sector. But, then (come July) both the dreams came crashing down!
The table topper Indian cricket team’s shocking loss to 4th placed New Zealand in the semi-finals came as a crippling blow to shatter the dreams of over a billion fans. One never knows what the future holds for the men in blue. The team has to start from scratch and wait for another such opportunity to dream of another World Cup trophy.
On July 5th, much to the disbelief of all in the gold industry, the increase in import duty on gold by 2.5% to 12.5% left gold staring at a bleak future. How can reforms take place in the gold industry if the higher import duty takes the trade backwards again towards an unofficial trade? For, the 12.5% import duty on gold plus 3% GST, high import duty on gold dore, as well as higher import duty on even silver and other precious metals cannot but push the trade into darkness. Not quite the obnoxious Gold Control Act, but inexorably towards unofficial trade (at least partially). Smuggling, as was prevalent during the 1980s shall never return.
At present, only the Myanmar route is open for such gold smuggling. But, gold is still unofficially entering the country through carriers (who operate as courier boys for others and bring gold on their person) from various locations across the globe without paying any duty at the airport. Apart from that, smuggling of gold often takes place by sending gold camouflaged in other imported goods, mainly by air. The spectacular rise in seizures of such goods at the airports over the last few years by the Customs and other agencies can only be attributed to an increase in gold smuggling. Independent research outfits on gold have estimated unofficial gold imports of well over 100 tonnes per annum since the import duty was increased to 10% a few years ago. Moreover, gold has been hit by a double whammy, not only due to the hike in import duty by 2.5% to 12.5%, but by the sharp rise in the gold price from an average price of $1,268 per ounce during 2018 in London to around $1,444 per ounce (intra-day) on July19th 2019 (an increase of around 13.9%). This could take gold out of the reach of investors who have the precious metal as the only asset to tide over tough times.
Gold duty’s impact
But, first let us look at the impact of higher duties on the gold market. The incidence of the higher duty structure of over 15.5% (12.5% import duty plus 3% GST) could only result in an increase in smuggling of the yellow metal, provided demand does not decline sharply due to the higher gold price. Given India’s affinity for gold, it can be inferred that smuggling should increase on account of the increase in import duty. Then, it is not only a question of smuggled gold but, hawala creeps in (unofficial price of the rupee) at higher rate for the rupee in unofficial trading. Finally, it may provide a boost to the parallel economy and make the gold market opaque. Obviously, an ‘open and shut case’ to close an argument, for lower import duty on gold.
However, an official from the commerce ministry said at a seminar a few months ago that there was no direct connection between higher import duty on gold and smuggling. The official clearly did not buy what the trade was trying to tell the audience at the seminar. It brought sharply into focus the trust deficit between the government on one hand and the gold trade on the other hand. What must also be understood is that the bullion trade has got a very bad image (dealers, jewellers, goldsmiths, traders, et al). They are seen as smugglers, black marketers, cheaters (purity of the metal), involved in hawala and the underworld. Any genuine grievance of this trade is often rejected at the first instance. Any talk by the jewellers of self-discipline, etc. has always been viewed with suspicion and scepticism. Then, the bullion trade does not have access to ready bank financing, often resulting in unofficial, unorganised and underground trade.
At the same time, the government needs to ask itself one question. Can it afford to allow the bullion trade running into billions of rupees (nay dollars) to remain underground, and out of the mainstream economy? Can such a trade with its vast network and reach continue to remain deaf and dumb? Can it be deaf to the numerous complaints about rampant cheating? And, why should it not have a say in policy matters affecting it?
Transparency is the first casualty when taxes or duties are unreasonably high. It prevents the gold market from being mature and reforms are harder to implement. During the period of the Gold Control Act (1960s to 1990), the gold market was opaque with the only source of the yellow metal being smuggled gold, often using dhows across the seas. Gold was smuggled into India mainly from Dubai, using the sea route. Bullion dealers, retailers, manufacturers et al then showed this smuggled gold or unofficial gold as scrap inflows into the markets from investors, etc. in their books. As a result, all data on gold in India was at best guess estimates.
Moreover, smuggled gold had to be financed unofficially and monies sent overseas illegally. These transactions were called hawala transactions and the hawala rate of the rupee/dollar rate was higher than the official Indian rupee rate. Therefore, for the supply side, gold imports numbers were based on production of tola bars in the refineries overseas. These refineries made tola bars specially for the Indian markets. It was said that tola bars could be fitted into customised jackets for smuggling of the yellow metal. Seizures by Customs and other agencies were indicators of gold smuggling. In spite of rigid controls on holding of bullion, the Indian woman’s affinity for gold and its main role as an investment option for most meant that demand continued to grow despite curbs.
Things began to change after the obnoxious Gold Control Act was repealed in June 1990 by the then finance minister Madhu Dandavate. After that, over a period of time, gold imports were first permitted under Special Import Licence (SIL), Open General Licence (OGL) and so on. The import duty too was changed from time to time and finally settled at R100 per 10 gms for pre-numbered gold bars of metric weight and R250 per 10 gms for other categories.
GOLD IMPORTS OVER THE LAST FEW YEARS
| (Tonnes) | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 |
| Gross imports | 1,211 | 969 | 783 | 828 | 904 | 511 | 876 | 757 |
| Price K/10 gms | 24,003 | 29,730 | 29,310 | 28,278 | 26,488 | 29,395 | 29,135 | 30,689 |
Source: GFMS, Refinitive
JEWELLERY CONSUMPTION
Hawala rates declined and almost fell to the same level as the Indian rupee. As a result, most of the gold imported was from official sources. One could safely say, then, that well over 90% of supply side data on gold were hard numbers. The parallel economy also took a hit. Gold and silver smuggling via the sea route became extinct. This continued till well into 2010-11.
But, the CAD crisis saw the import duty raised manifold to 10% over a short period of time and both hawala and smuggling reared its head with a vengeance. The parallel economy too got a boost and some portion of the trade went underground as well. While the steep hike in import duty saw a decline in official imports and thereby improved the CAD situation, smuggling and the boost given to the parallel economy made one wonder whether the remedy was worse than the disease. The additional burden of 3% GST only adds to the situation and acts as an incentive for some in the trade to go underground.
Over a period of time, one gets the feeling that the mandarins of the finance ministry are more concerned with what the official numbers are for gold and even silver. Probably, they discount for gold smuggling and are focused on the limited objective of keeping CAD under control and not affecting India’s credit rating overseas. It is more akin to this era of super speciality services in the field of medicine, wherein, a doctor treating a patient for a particular ailment may refer the side effects of the medicine to some other expert. So, the finance ministry is more concerned with keeping CAD under control and not fretting over its impact on the overall economy or the boost given to the parallel economy by way of smuggling of gold due to higher import duty.
Then, the other aspect of the ministry officials is that some of them seem to be from the ‘Morarji School of Gold’. They view gold as a dead investment and an evil that has to be curbed. Not only that, they want to drastically reduce import of the yellow metal as well as its consumption. They would be more than happy if higher import duty resulted in lower gold imports. For, most of the time the government’s response to any crisis has often been an ad-hoc or knee-jerk reaction. As a prominent speaker, at a recent seminar, put it rather succinctly, “band-aid type of system, lack of coherence and no focused approach”. A case in point being the response of the then government to the CAD crisis, it promptly blamed gold and hiked the import duty on gold to 10%. Similarly, the response to round-tripping of gold initially was to decrease the number of days for export remittances from 360/270 days to 90 days. Thereby, blaming and punishing the entire gems and jewellery export segment for transgression by a few players. This scenario has repeated itself umpteen times before – wherein gold is first blamed, then prosecuted, judged and punished by the government departments. They merely look at gold as a cash cow in times of revenue shortages and some zealots wish to make India ‘gold mukt’.
Rural dilemma
What is seldom realised is that gold is the only form of investment for rural India (mainly the farmers). With poor banking penetration in most parts of India, the farmers mainly buy gold or silver from the proceeds of their crops, they then sell the yellow metal to buy seeds, or when the going gets tough.
The Jan Dhan accounts, though impressive on paper, have not been able to deliver on its promise. These accounts are more in the news for misuse by vested interests. So much so, that the finance minister in the budget put a cap on cash deposits in bank accounts without the consent of the accountholder. The post office bank too seems more interested in showing numbers. Moreover, what seems lost is that gold in the hands of individuals (both in urban and rural areas) acts as a buffer in times of global financial shocks. India was largely insulated during the EastAsian currency crisis in 1996-97 as well as the global meltdown during 2008. In contrast, when the erstwhile USSR was breaking up, Russia sold almost all its gold reserves. It was not only a gold producing country, but held large quantities of gold as reserves in its central bank. Unfortunately, individuals in Russia do not hoard gold in large quantities.
Today, even though Russia is still a major military power, economically it is no match to most of the developed world. It did not pay any heed to gold then. Strangely, in the last few years, in spite of higher gold prices, Russia is regularly adding gold to its reserves. During the current year alone, many of the world’s central banks have bought gold as a policy. Among them was the Reserve Bank of India (RBI) as well. No one wants a repeat of the 2008 global meltdown. The moot question is if the RBI thinks it proper to buy gold, then why is the yellow metal being pushed out of reach of the individuals, mainly from rural India?
Do the decision makers at the finance ministry ever wonder why the US has over 8,000 tonnes of gold in its reserves? Why most of the European central banks have more than 1,000 tonnes of gold. China has over 1,800 tonnes of gold with its central bank. Even the RBI has over 600 tonnes of gold and India is now the tenth country in the list.
But, India’s biggest buffer against economic strife has been the 20,000-25,000 tonnes of gold with individual households and institutions. Most of the gold in households is held by the middle class; they hold on to it and will use it only as an absolute last resort. No wonder all the gold monetisation schemes have failed to kick off. The moment they release their gold and some financial whizz-kid utilises it in ‘productive schemes’, the Indian economy would have no buffer to fall back upon.
The high incidence of duties (import duty at 12.5% plus 3% GST), makes gold too expensive for farmers to buy. Not only that, import of gold coins is banned for some time now. Then there are various restrictions and curbs on gold from time to time, ostensibly to prevent misuse by players in the industry. Since 2004-05, gold prices have moved higher almost every year, with an all-time high of $1,921 per ounce in mid-September 2011. This made gold very expensive, mainly for the rural Indian.
The 10% import duty made it out of reach of most retail investors of gold in India. The recent additional burden of the 2.5% hike in import duty coupled with the 3% GST could be the proverbial last straw on the back of the already burdened rural investor, mainly the poor farmer. Is it a mere coincidence that farmer deaths have increased over the last decade or so? With gold increasingly out of reach of the poorer farmers, due to its high price, their ‘gold cover’ is getting depleted. Future global financial shocks may find no buffer in rural India now!
A look at the chart on gold imports over the last few years shows that apart from only two years, gold imports have not declined sharply. The first time was in 2012 in the aftermath of gold touching all-time high levels of $1,921 per ounce in September 2011 and the average gold price of R29,555 per 10 gms for the year 2012. Then, gold imports had slumped from 1,211 tonnes during 2011 (buoyed by expectations of higher gold prices) to 969 tonnes in 2012. The next slump in imports was in 2016, when gold imports fell to 511 tonnes, when the gold market was hit by demonetisation and the 42-day strike on account of reintroduction of excise duty in that year’s budget.
Insatiable appetite
Otherwise, in most of the years, gold imports appear to increase in spite of the rise in gold prices. The thumb rule being that even at high prices, demand for gold does not slacken to a great extent. A sharp spike impacts demand for a short period of time but demand returns once the price stabilises. It is not the price rise per se, but price volatility that impacts gold demand. Even if imports may be hit due to the higher duty, the increase in estimates of smuggling numbers shows that demand cannot be curbed so easily. Then, trade sources opine that smuggling numbers may be higher than what is estimated by independent agencies. Even the estimates of jewellery consumption could be much higher than what is reported by independent research outfits. For, in arriving at the jewellery consumption estimates these outfits take into account only new gold sold at the retail level. They do not take into account the exchange of old jewellery for new. The definition of scrap is confined to gold sold for cash and once again the exchange is ignored. Therefore, while the traders would talk in terms of their performance or business done in a specified period, it will include even exchange of old jewellery for new. As a result, their consumption estimates could be at variance from the numbers from the above mentioned agencies. Then, the estimates of imports (only official or including smuggling numbers?) as well as exports could be lower or higher than the actual number. Therefore, anyone from the authorities could come to an erroneous conclusion on the impact of import duty on demand for gold.
ESTIMATES OF UNOFFICIAL GOLD IMPORTS AND ROUNDTRIPPING
The gems and jewellery sector is a major foreign exchange earner with gross exports of $39.6 billion during 2018-19, down from $42 billion not so long ago. With all the major gems and jewellery consuming centres in a decline and not consuming as before, India’s exports have been impacted. Moreover, the diamond exports appear to have reached a saturation point and have either reached a plateau or have declined.
One may not see any dramatic increase in diamond exports unless the US market suddenly picks up. Even the largest diamond supplier (De Beers) recently decided to restrict its output in the second half of 2019. So, the only option to increase exports from this sector is studded and plain gold jewellery exports. The value addition in both categories of jewellery could boost exports from India. However, for any export industry to grow, there has to be a robust and thriving domestic market. Unfortunately, the high incidence of import duty as well as GST renders the domestic market uncompetitive to boost exports or even be innovative in its products. More so, as a substantial portion of gems and jewellery exports still come from the Domestic Tariff Area (DTA) in and around Mumbai. In the wake of the above scenario, the dream of making India a $5 trillion economy could well be hampered to a certain extent.
Finally, in a strange quirk of fate, most of India’s commerce ministers have been great friends of the gems and jewellery sector. They have always strived hard to boost exports from this sector. However, more often than not, their attempts to give additional incentives to this sector are thwarted by the finance ministry. Therefore, many are happy when some of the erstwhile commerce ministers become the finance minister of the country. However, a reality check shows that the erstwhile commerce ministers change when they become finance ministers. Consider the following: P. Chidambaram as commerce minister is said to have rushed from the commerce ministry to the finance ministry to argue in favour of the gems and jewellery sector. But, the same P. Chidambaram as finance minister ultimately raised the import duty on gold to 10% in 2013 to tide over the CAD crisis.
Likewise, Arun Jaitely as commerce minister had freed gold imports around 2003. He famously said, ‘even a paanwala can import gold’. That never happened and as the finance minister he did nothing to reduce import duty on gold. Even the incumbent finance minister as commerce minister was perceived to be a great friend of the industry as she strived hard to help the industry. But, as finance minister, she set the gold trade back by increasing import duty on gold to 12.5%, instead of reducing it.
It would seem that the two ministries are at sixes and sevens with each other. Probably, it is the right time to merge the two ministries into an Economic Affairs ministry so that all policy decisions take everything into account and all concerned are on the same page. Otherwise, the two ministries will constantly be at loggerheads with each other and that is simply not good for the gems and jewellery industry.
LBMA: Gold To Inch Higher In 2019
The LBMA initiates a precious metals price forecast by involving precious metals analysts from around the globe. It generally conducts the exercise at the end of January every year. This year’s price forecast threw up some interesting facts (see chart alongside). What it showed was that analysts around the world were not very sure about the price trend for gold during 2019. The average gold price predicted for 2019 was $1,311.71 per ounce, just 1.78% higher than the actual average price in the first half of January 2019. While the high for the year was predicted at $1,475 per ounce, the low was $1,150 per ounce. The range was $325. One could have safely inferred that it would be a quiet year for gold.
However, gold was pretty active in the first half of the year and on July 19th 2019 it scaled a six-year high of around $1,450 per ounce (intra-day). So, why is gold on a roll? Is it a flash in the pan, or is gold now in a bull run? For, in recent months, the gold price has progressively increased after every decline. Moreover, every lower price is higher than the previous low. Most experts now expect gold to touch $1,500 per ounce before the year end. There are a few now who see $1,600 or even $1,700 per ounce in the last quarter! What is behind this gold rally? Is it here to stay?
Several factors contributed towards the recent surge in the gold price:
(a) Central banks across the world, including the RBI, purchased 651 tonnes of gold in 2018, the highest in decades. The same trend continues in 2019.
(b) The US Fed has been dovish in its outlook and that is what propelled gold forward during the recent gold rally. The markets expected a 0.25% to 0.50% rate cut in the July 30th-31st meeting.
(c) Likewise, the European Central Bank (ECB) was expected to announce rate cuts and stimulus to boost the markets. The fact that the ECB just announced the intention to restart the stimulus process from September caused gold to scale down from around $1,429 per ounce to around $1,414 per ounce.
(d) Positive US economic data often pulls down the gold price. But, any data below expectations acts as a boost to the gold price.
(e) The over-valued US dollar and the weak GDP in the US at around 1.6-1.7% aid the gold price.
(f) The fact that the US is in a trade war with China and engaged in tariff disputes and sanctions against many more countries adds to the imbalances in the system and propels the gold price forward.
(g) Geopolitical tensions in various regions of the world, particularly around Iran, acts as instantaneous fuel to higher gold prices. Any news about confrontation in the Strait of Hormuz adds to the tensions and one can see the gold price zoom forward.
Technical chartists also project the gold price to move higher, with more chances of an upside, with strong support levels near $1,400 per ounce. So, will gold price zoom ahead or retrace its step? The situation is very fluid and much depends on how the US markets behave. Too many of the factors mentioned above are under the influence of one man. And that is the crux of the matter!
LBMA PRICE FORECASTS 2019
PRICE RANGE
