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Reforms for the Indian gold industry

– By Somasundaram PR, Managing Director, India, World Gold Council

On July 5, 2019 in the annual budget, the customs duty on gold bar and gold doré was raised by an additional 2.5%. The custom duties on gold bar and doré now stand at 12.5% and 11.85% respectively. With an additional 3% Goods and Service tax (GST) on top, Indian consumers pay in excess of 15.5% tax for refined gold. This came as quite a surprise to the entire industry - which was actually expecting a duty cut! 

The context behind this development is key to understanding the potential implications. This was not an isolated move targeting gold. It was part of a broader revenue-raising budget: taxes on most of imported items, including oil, electronics, automobiles and books, increased along with personal income taxes of higher income group, which saw the tax rate increase from 35% to 42.7%. This was also not borne out of any reaction to unprecedented gold demand or inflation as in 2013. In fact, unusually, gold taxes have gone up first time when inflation is benign, and demand is just normal. It is unfortunate but perhaps unavoidable in the immediate fiscal context.

In the financial year 2018-19 the tax to GDP ratio fell to 10.9%; 0.3% lower than previous year. The shortfall in revenue is primarily due to to lower-than-expected GST collections which fell short by around US$11bn. This additional 2.5% custom duty on gold might add approximately US$800mn to the government’s coffers in the current fiscal year- but for that to happen, containing grey market is key and that is where continuing structural gold reforms is key.

This tax increase should not be looked at in isolation. Higher earners in India are hugely relieved that a much talked about inheritance tax has been shelved. The budget also contained unprecedented levels of support for rural India, including double farmers’ income by 2022. And lacklustre stock and debt market performance has already made gold one of the best performing asset on 2019 (Table 1). The factors bode well for future gold demand.

 

Table 1: Returns on gold vs. other asset class

 

Gold

Sensex

NIFTY 50

India 10-year government bond

9.1%

7.4%

6.4%

8.1%

 

* Returns are y-t-d returns as of 8 July 2019. Gold return is based on MCX Spot gold price and Bloomberg 10-year India government bond return index

Source: Bloomberg

 

Consumer awareness of duty is low, consumers do not see the duty during a purchase - they only see GST of 3% on the invoice, so this increase is expected to pass off as part of the already significant rise gold price in recent times due to international factors. Econometric analysis we published in our report India’s gold market: Innovation and evolution, indicated that a 1% increase in gold’s import duty may decrease consumer demand by 3 tonnes (t) per year in the long-term.

 

The important message to take away is that the effect is negligible. The long-term impact of this price rise is just demand is just 7.5t - insignificant. Even the short-term impact is small compared to the 750-850t annual demand. The logic underpinning this is that the 2.5% duty hike is relatively small in the context of the overall transaction. For example, gold price rose 8% in June 2019 alone.[1]  Moreover, the hike has come into effect during the monsoon season, a traditional quiet period for gold. This gives the industry and consumers time to adjust the expectations ahead of the all-important gold-buying period during Diwali in October.  However, it is a fact that such price increase – whether due to duty or other factors - will hit small buyers who need jewellery for social occasions severely and create long term cultural impact.

The compliance in the industry post introduction of Goods and Services Tax (GST) was improving and industry was getting a lot more organised. This trend is likely to be disrupted in account of two reasons, one consumer resistance to overall higher prices exacerbated by duty hike and the lure of the grey market. So compliant organised players will now have to compete with an active grey market. While surveillance has improved post GST, grey market is innovative and a threat to gold reforms. Gold was also trading at discount of US$ 33 per ounce which shows the impact on certain sections of the industry.

The immediate task for both the government and industry must be to ensure that grey market is curbed so a level playing field is created for all players. Else, as it happened at the time of introduction of GST in 2017, some players will benefit at the cost of the organised and the compliant.

If we chart successive measures of reforms on tax compliance since demonetisation, the government is clearly intent on reforming the gold market. There should not be a hiatus in the path to gold industry reforms announced in the Watal Committee Report on Transforming India’s Gold Market of NITI Aayog. Structural developments such as the Gold Spot Exchange, Bullion banking, Hallmarking and integrity of gold, Good Delivery and Responsible Sourcing, etc under an over-arching policy should gain greater government attention and time bound action – so the objectives of the duty hike are met.

 

Import duty increase, in a way, could also prepare the Indian trade for a bigger role in the global gold price through India gold spot exchange. For example - China for has 17% VAT on gold but if gold is bought through Shanghai Gold Exchange (SGE), it is exempt. This could very well fit with India’s ongoing gold reforms.

 

India cannot compete in the exports market without addressing its domestic market issues on standards and infrastructure. And without exports and an organised, fully complaint domestic market, gold cannot emerge from the shadows of CAD and grey market – both inviting adverse government action on and off. Spot Exchange, Innovation, making a strong case for gold among investors, reliable data, a code of conduct which, inter-alia, leaves no space for the grey market; these are the priorities.

Gold demand cannot be wished away. The culture of conservatism and savings embedded in gold buying should not be entirely replaced by other consumption imports or risky savings. Gold reforms debated over the last 4 years should be pursued with vigour by the industry with the support of the Government. Industry’s potential should be tapped to fit nicely into India’s $5 trillion target by 2024, this dream cannot skip gold. Gold is an important industry with employment potential and it holds Indian household savings of over US$ 1 Trillion. 

Disclaimer: Views are personal and not the views of the publisher.



[1] Domestic price on 5 July closed at 8.1% higher as compared to end of May price