The government announced its plan to raise duty on gold from 4% to 6% today, and the worry about our current account deficit is the reason behind this increase.
India imported gold worth $38 billion till December last year, and this is foreign reserve that went out of the country. By increasing the duty on gold, the government hopes that it will slow down the purchase of gold, and ease the strain on forex reserves somewhat.
While I don’t know how much of an impact this 2% hike will make, if any at all, I have a feeling that this is not the last hike we have seen. Unless gold prices cool down a bit, people will continue to invest in it and at least from an investment point of view, the high price is driving the demand, and if the price goes any higher then that will drive demand higher as well.
The second step that was announced is more interesting than the gold duty hike, and that is of linking gold ETF schemes to bank’s gold deposit schemes.
When you buy a unit of a gold ETF, it represents about a gram of gold (half a gram in the case of Quantum) and the gold ETF sponsor buys and stores gold on your behalf with a custodian. This gold is lying idle so to speak, and the government has ideas to make use of this ‘idle’ gold.
The ETF’s gold will be linked to gold deposit schemes where jewelers can borrow the gold from banks and pay interest on this gold, and at a future date pay the money equivalent to the gold that they borrowed at the then prevailing price.
This will help reduce the import of gold to the extent that it is borrowed, but in the long term if the demand for gold doesn’t come down then I don’t think this will really reduce imports, it will perhaps play a small role in delaying the imports but not make a long term impact on lowering gold imports or the current account deficit.
However, this should be good news for ETF owners because any interest that the ETF earns out of lending gold will ultimately accrue to the owners and juice up their returns. The details are still to be worked out, but if the lending starts, it should add to gold ETF returns. (Read: Best Gold ETF Funds in 2012)