The Gold Tax

wealthymatters.comThe following is the work of Ila Patnaik,a professor at the National Institute of Public Finance and Policy, Delhi.It was published in today’s Indian Express.

These days it is fashionable to talk about how gold is draining away India’s precious forex,how gold is the refuge of black money and how opting for gold is somewhat anti-social and unpatriotic.I decided to post this article here to remind people of how gold has long been a good friend of Indians of all classes and especially of Indian women.Gold has been around a lot longer than the subject of economics and economists.Economic fads come and go but gold worked for our grandparents and will not fail us.Keep your gold.Hold it as bullion or high karat jewellery and keep it safe and do not be tempted,pursuaded or coerced to exchanging it for paper of any sort whether currency notes or gold deposit/accumulation schemes,ETFs,certificates or dematerialized units.

Having said my piece I will now leave you to get on with reading the article below

With increased import duties on gold, we return to pre-liberalisation thinking

The inflation crisis of the last six years, coupled with a persistent lack of financial inclusion alongside a decade of high GDP growth, has given an upsurge in demand for gold. The increase in custom duty on gold proposed by the Union budget, and the reduction in the loan-to-value ratio of gold loans by the RBI, will hurt the poor.

The Union budget has proposed a doubling of the custom duty on gold imports. In the eyes of policymakers, Indian households are consuming “too much” gold. Raising import duties would make gold costlier and is expected to restrain gold purchases. Implicit in this argument is the idea that the government knows what is best for the household and for the country. The omniscient state guides households towards the right choices on buying gold or petrol through tax and subsidy policies. This kind of thinking is reminiscent of India in the pre-liberalisation days. Mobile phones were considered inessential, so there were high customs duties on them.

Ironically, it was when Manmohan Singh became finance minister, India moved away from the thinking that imports of consumer goods was bad, and among them that of luxury consumer goods was even worse. Customs duties on gold were removed; gold smuggling and the associated criminality collapsed. Today, when he has ascended to prime ministership, we are regressing into old policy instincts. Gold is easy to smuggle; perhaps we will now once again get Bollywood movies featuring fast boats from Dubai or Pakistan carrying gold to India.

But gold is not merely a consumption good. It is also a financial asset, particularly for the poor who are excluded from mainstream finance. Gold is particularly important in shifting power within poor families to women. Often gold jewellery is purchased through a loan from the local jeweller by a woman who quietly saves a few hundred rupees when possible and pays him towards the purchase. In the end, she owns a financial asset that is liquid, that is, can be sold easily, or used as an excellent collateral for taking a loan.

Why is gold fascinating to many? One part of the story clearly lies in India’s failure in financial reforms. By failing to transform the financial system, we have failed to achieve financial inclusion. A very large share of households in India are unable to save money in banks as either there are no accessible bank branches, or the amounts the households save are too meagre. Other financial instruments such as equities are out of question. For them, gold looms large in financial transactions. As long as we do not achieve fundamental change in finance, we have to respect the role that gold plays for the poor.

The second important motivation which pushes households towards gold is our failure in building trustworthy paper money. In an environment of persistent inflation, the public mistrusts cash, and gold is seen as a hedge to inflation.

The alternative for those who have access to banks is to put money in the bank. With a savings bank deposit rate below the inflation rate, households earn a negative interest rate on their savings: everyone using bank deposits is paying the inflation tax. With gold there is a hope that gold prices will keep up with inflation, and the household will be able get a loan against the gold in a time of need.

Moving from the Indian rupee to gold reflects a lack of trust, in the eyes of households, about prospects for low inflation. Buying gold is a vote of no confidence in the ability of the government and the central bank to deliver low and stable inflation. The right thing for government to do is to recognise that inflation is a serious problem, and set about building a central bank that is dedicated to delivering low and stable inflation. Instead, the government is resentful of the popularity of gold as competition against the Indian rupee.

In many districts of the country, up to 90 per cent of the population does not have access to organised credit. There the best way for the family to borrow is to mortgage gold. Typically gold jewellery is mortgaged. Earlier it was with the village money lender. Today it may be with a gold loan company, to typically obtain loans of Rs 50,000 or less. The interest rate on the loan, at 12-24 per cent, is less than what the money lender charges.

A week after the Union budget, the RBI increased the loan-to-value ratio required for gold loans given by Non-Bank Finance Companies (NBFCs). This will reduce the size of a loan against gold to 60 per cent of the value of the gold, from the present value of 80 per cent. This step will reduce the usefulness of gold as a financial asset that can be used in times of need.

This will hurt the interests of the poor who were able to build up gold assets which were used as collateral for obtaining loans from NBFCs in times of need. These households will be driven back to informal loans from money-lenders or goldsmiths, where the terms are generally more adverse as compared with the offerings of NBFCs.

The RBI probably resented the success of NBFCs giving loans to households, who were doing a better job of serving the needs of households when compared with banks. The right thing for the RBI to do is to recognise there are fundamental problems in banking, to end financial repression, and set about building a banking system that is able to offer positive real rates of interest.

If higher imports of gold are seen as a problem by the government, it needs to solve the problem by increasing financial inclusion, by reducing the inflation rate and by keeping inflation low and stable. It needs to move away from financial repression where banks are forced to lend to the government at low rates, and then offer negative real rates of return to depositors. The importance of gold will not reduce simply by the taxman stepping in, or by making it harder for NBFCs to give gold loans.



About Keerthika Singaravel

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