In the previous article, I went over my initial thoughts and concerns over the drastic lowering of the total customs duty on gold from 15% to 6% . While I discussed a few significant pros and cons from the perspectives of both the public and government in the last article, I felt an in-depth analysis behind some of the government’s ulterior motives was necessary to gain a deeper understanding behind this huge tax cut. While it isn’t possible to know the exact reason/reasons this economic decision was made by the government, I will be exploring some potential reasons out of which all, some, or maybe even none might be true in actuality.
India holds over $675 billion in foreign reserves, out of which a significant portion is in U.S. dollars. One of the possible reasons for reducing customs duty on gold imports is that the government may be seeking to diversify these reserves. The heavy reliance on the U.S. dollar exposes India to risks that come with currency fluctuations and geopolitical tensions involving the US. By encouraging legal gold imports, the government might be aiming to increase the country’s gold reserves without having to store large quantities directly in its vaults. This gold, even when distributed within India, would still represent a physical asset that could be utilized in times of need, therefore improving the stability and security of the nation’s wealth. Another potential reason for the customs duty reduction could be related to the Indian rupee’s performance against the U.S. dollar. As the rupee continues to face downward pressure, gold offers a safer hedge against currency depreciation. By making gold more accessible through lower import duties, the government could be encouraging citizens and institutions to invest in gold as a hedge against the falling rupee. This strategy could help stabilize the currency in the short term and provide some safety in case of future economic shocks.
Moreover, gold smuggling has long been a significant issue in India. It is estimated that around 30% of the gold enters the country through illegal channels, primarily from neighboring countries. This equates to approximately $10 billion worth of gold annually. A major concern regarding this point is the potential link between gold smuggling and other illegal activities, such as drug and weapon trafficking. Since no surrounding economy around India is large enough to absorb 10 billion dollars in cash, India must be exporting similar amounts of illegal substances to balance out the trade. Thus, by cracking down on gold smuggling, the government could indirectly address these broader security concerns, particularly in border regions where smuggling often causes other forms of crime and instability.
Conversely, India’s borders, particularly with countries like Nepal and Bangladesh, are notoriously porous, making them prime locations for smuggling activities. The profitable nature of gold smuggling has been a persistent challenge for law enforcement and has had destabilizing effects on border communities and villages. By reducing customs duties, the government might be attempting to reduce the incentive for smuggling, thereby reducing the strain on border security. If successful, this could have a similar effect on other forms of smuggling and illegal activities, helping to stabilize these vulnerable regions and enhance national security.
The timing of this policy change is also noteworthy. The first installment of the Sovereign Gold Bonds (SGB) is about to mature, which means the government will soon need to pay out these bonds. By reducing customs duties, the government might be attempting to lower the payout burden by increasing gold supply and potentially lowering gold prices. This move could be a strategic effort to manage the financial implications of the SGB program, which has been a popular investment vehicle in recent years.There are also rumors that the government may consider increasing the Goods and Services Tax (GST) on gold to offset the loss of revenue from reduced customs duties. If this were to happen, it could create a new balance between the desire to encourage legal gold imports and the need to maintain government revenue. Such a move would reflect the government’s attempt to maintain financial responsibility while adapting to the evolving economy.
Lastly, the Indian banking sector has been struggling with a shortage of deposits, as more people turn to mutual funds and shares for investment rather than traditional bank deposits. By bringing gold into the mainstream economy through reduced customs duties, the government could be encouraging people to invest in gold through banks. This influx of gold could help banks increase their deposits, helping them to lend more effectively and contribute to economic growth. Furthermore, if banks sell this gold to raise capital, it could provide them with much needed liquidity, helping to address the current challenges in the banking sector such as the reduced growth rate of bank deposit interest rates as compared to the rate of bank loan interest rates.
While the reduction in customs duties on gold imports in India’s 2024 budget is a complex decision, it is clear that the government has considered a variety of economic and security factors. Whether it is diversifying foreign reserves, combating smuggling, strengthening border security, or stabilizing the banking sector, this policy move could reflect a strategic attempt to address multiple challenges simultaneously. However, the true impact of this decision will only become clear over time as the economy adjusts to these new dynamics. As with any bold policy decision, there are risks involved, and only time will tell whether this approach will provide the intended benefits.
