Gold duty raised to 6% and plans to free gold ETF assets

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)

8 thoughts on “Gold duty raised to 6% and plans to free gold ETF assets”

  1. Manshu, by reading your post I understand that the demand for gold would eventually come down than the current levels. Do you mean to say that the current gold ETF prices would also come down? I have some gold ETF units, do you think (from a returns point of view), it makes sense to quit and invest somewhere else?
    Thanks for your suggestions.

    1. I meant that eventually gold prices will come down, but no one knows when so you can’t really quit now in the hopes of getting a higher price elsewhere. That is just an opinion and I have been mainly wrong about gold prices in the past so I don’t know if you should put much weightage to it.

  2. Doesnt make sense, why is the ETF buyer being asked to take additional risk. Its like converting a commodity to a debt instrument without the buyer’s buy-in. This sort of complication of products is what led to the Mortgage crisis(CDS)

    1. It makes sense to the extent that people are allowed to choose whether they want to be invested in such ETFs or not. There are several ETFs in the market today and then other options like e-gold so people who aren’t comfortable with this can switch to those other funds.

      1. e-gold requires me to look at a different exchange and create an account just for it unlike ETFs. If this applies to all Gold ETFs where is the choice?

        1. I think a lot of people are going to have reservations like you have, so when they chalk out the details I hope they give people an option to opt out of loaning their money for the same fund. Have two different NAVs for the same scheme or something like that.

  3. This is charting into dangerous territory, so now ETF owners will become Risky lenders, The financial turns that can be taken never cease to amaze. This could very well be the end of Gold ETF as we know a few more jobs will be added in 1crore + category for managing the lending.

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