Higher duties on gold and silver may not be silver bullets, say experts

Even as the Central government expects the decision to double customs duty on gold and silver from 6% to 15% to help maintain macroeconomic stability and reduce pressure on foreign exchange reserves, experts say such policy measures may not always achieve intended results.  

“Trying to micromanage consumer and industry behaviour via trade policy has substantial tradeoffs that we have to be careful about. It can create more problems than it solves”, says Rahul Ahluwalia, Founder Director, Foundation for Economic Development. According to him, “the import duty hike may negatively affect employment and exports in the jewellery sector and the ability of Indians to invest in one of the best performing asset classes at a time of global uncertainty.

Sachin Sawrikar, Founder and Managing Partner, Artha Bharat Investment Managers says the duty hike may not achieve its intended purpose.  “The sharp jump in effective import duty on gold and silver, from 6% to 15%, is a blunt instrument that history tells us rarely achieves its intended purpose”, he says. “India's appetite for precious metals is structural, not cyclical; it is woven into savings culture, festive demand, and portfolio behaviour across hundreds of millions of households. When the price of the legal channel rises this steeply, a well-established informal trade (call it grey-market or smuggled supply) simply fills the gap”, Sawrikar says. “We saw exactly this play out after the 2013 duty hikes, which drove an estimated surge in gold smuggling even as official import data showed a decline. The forex savings the government hopes to achieve may prove largely illusory, while consumers end up paying a premium, jewellers face margin pressure and compliance costs, and enforcement agencies are stretched further”, he adds.

Ajay Srivastava, founder, Global Trade Research Initiative says the tariff increase sharply changes the economics of precious metal imports routed through the United Arab Emirates under the India-UAE Comprehensive Economic Partnership Agreement (CEPA). “The concessional tariff on silver imports from the UAE currently stands at 7%. With India now raising the general tariff to 15%, the duty gap has widened to 8 percentage points, creating a major arbitrage opportunity for imports routed through Dubai”, he points out. The difference is not that high in the case of gold. With the new MFN tariff structure taking effective duties to 15%, gold imported under the UAE quota would enter at 14%.

The experts say the government has other options, though unpopular, to manage the situation.

“A better approach would be to let the rupee depreciate to its natural level and prices of oil products to reflect ground realities. This will make all imports more expensive, and oil products more expensive in particular, but in a global crisis, that will incentivise Indians to reduce or substitute imports and oil products. These steps may be politically unpopular therefore it is our responsibility to understand why it is important and support the government when it takes the right policy measures”, Ahluwalia says.

Sawrikar says a more durable solution to managing the current account impact of precious metal imports lies in improving domestic gold monetisation schemes and developing liquid gold-backed financial products, instruments that channel demand without requiring physical import at all.