Yellow fever

Raising duty on gold imports may help, but attracting foreign investment is the long-term solution

With the brisk pace of gold imports eating away at the current account balance, the finance minister has a problem on his hands. Higher imports of gold mean the government has to make more foreign exchange available to finance the inflow, which puts pressure on the rupee to dip compared to the dollar. A lower value of the rupee means the attractiveness of domestic financial instruments declines, making gold even more desirable. To this, add the unflagging draw of gold for Indians. The high inflation of the past few years has also added to the lustre of gold as a safe haven. In the GDP figures for the second quarter of the year, the expenditure on valuables, largely gold, has risen to 2.6 per cent of the GDP. However, this is less than the 3.4 per cent logged in the same quarter last year, which means the pace of growth has come down.

With this rate of growth, P. Chidambaram has indicated that he will raise the basic customs duty on gold, to make it more expensive to import. No doubt, the measure will have some impact. But it could also stimulate the dormant business of gold smuggling. Since this is a major source for the generation of black money and crime, the implications for the economy could be serious. It also turns out that gold imports, though rising, are not the fastest growing element in the list of India's financial transactions with the rest of the world.

A more impressive factor is the share of investment income outflows in the current account deficit. As a JP Morgan research paper points out, the repatriation of FDI profits and interest outflows have jumped in the last two quarters to a substantial 1.2 and 1.4 per cent of GDP. This is the money multinational companies send abroad as their profit and the payment of interest on the huge external commercial borrowings (ECB) and trade credits contracted by domestic companies, from abroad. The stock of ECB has increased by 40 per cent over the last three years. This is a rise that is going to be a long-term phenomenon for the economy and will soon overtake the impact of gold. In which case, chasing after the yellow metal would not help bring down the current account deficit that has ballooned to 5.4 per cent of the GDP in the same second quarter. The answer, then, is to make the Indian economy attractive enough to draw in more global funds to finance these imports.

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