Currency controls like India's block on gold imports
is a symptom, not a cure...
WHAT'S GOING on in India is nothing new, writes Miguel Perez-Santalla at BullionVault.
We've seen it over and over again throughout
struggling economies. It's called currency control. These attempts to
control movement of currency are very common when a government is faced with
problems like India's. They
actually create a more crippling environment than the one they are put in
place to improve. And make no mistake, controls on the movement of gold is a
control on the movement of currency.
Gold
has always been and will always be the safe haven of choice when people lack
confidence in their government. Lacking confidence doesn't only mean that
they're not certain they'll perform well, but it also may mean that they
don't trust their government to operate in their best interest. Starting with
allowing economic freedom, and defending the value of the currency.
What
are these currency controls recently put on gold in India?
- They've prohibited and
restricted loans to customers on gold bullion;
- They've raised the import
tax on both gold and silver to 10%;
- The sale of gold may
only be made to jewelers or bullion dealers to supply the jewelry
industry;
- Gold importers must
ensure that 20% of all gold imported is to be exported as product.
Oddly
enough, the Royal Bank of India and the government are so concerned with the
balance of payments that they miss the most important responsibility they
have. It is not to control the outflow of capital, but increasing the inflow
of capital. Free trade, when enabled both ways, will find an equilibrium that
will benefit all parties.
India's
finance minister Palaniappan Chidambaram is attempting to do just that, but in the interim the laws
that they put in place are hurting one of their key industries, the Indian
gold jewelry trade. Estimates vary, but one puts the jobs at risk of being lost if the controls stay in place
at half-a-million. This will force the people in that industry to search out
other solutions.
Trying
to interpret the government's regulatory actions has caused foreign
investment in India to plunge over the past year, while capital expenditure
at home may fall further in the future. Because as usual, when a country
attempts to control business, then business goes elsewhere.
The
chairman of Cipla (a large pharmaceutical company), Yusuf Hamied, in a recent
interview with the Indian business newspaper The Business Standard,
said that thanks to India's unpredictable tax regime, "All big Indian companies are going abroad. The time has now
come for us to say goodbye to India."
Why
not blame gold? From 2011 to 2012 India's gold imports increased nearly 50%
to an estimated $57.5 billion. Of course, this does hurt their account
deficit and it is something they should be concerned with. But their attempts
to close the gap by controlling gold flows are again the wrong tack to take.
What
happens when governments impose restrictions is that they also increase
crime. With a 10% duty on gold, the profit to smuggle
gold bullion into India has increased. Though some of the smuggling will
be caught, much will make it into the country representing a loss of revenue
to the government. Ten percent is just too high of a spread to be borne by
the Indian public and market for which the gold is intended.
A
recent article by Bloomberg details how gold-smuggling gangs from the Middle East are now
entering this business. Some Indian jewelers are willing to buy from anyone
that can bring them lower cost gold, because it enables them to keep their
business running. Otherwise they can only live off the scrap metal they
receive from the marketplace.
Banks
and traders halted imports of gold bullion during August, after the central
bank linked inbound shipments to re-exports. So gold supplies have become
difficult to come by. But the recent collapse of the Rupee by 18% has
increased the amount of gold being turned in for cash by Indian households,
who are also faced with a "credit crunch" caused by the
rising financial crisis. And so once again, gold – which their government
informs them is not a proper investment – has saved the individual by
providing liquid funds just when they're needed.
How
does this affect the external gold market? The answer so far is very little.
The market in China is constantly growing and China's gold demand may overtake India as the largest
consumer in the near future. Physical demand for gold
coins has been strong globally. But India's traditionally strong period
of festival and wedding demand now running to Diwali in November will likely
see much lower gold imports through official channels.
Of
course, gold will still flow where it is needed. The controls that the Indian
government has established have done little to stay the hands of investors.
It's
almost too simple to believe that the government cannot recognize where their
focus should be. India's gross domestic product growth rate has been on decline
since 2011 from a high of 9.3% to
currently 4.4%. Capital outflows, distrust of government regulations, and
the inability to get businesses active in India are the primary causes of
this government's troubles. If the business environment were to be improved
then the economy would grow as well. The people themselves would reinvest
into their country.
In
the current environment, in which industry is stifled and unable to grow
within India, then we can expect to see, sadly, a decline in confidence and
GDP. Continuing down this path will inevitably lead to another economic disaster such as Argentina is suffering, along
with many other countries with closed markets.
In
a country like India, where they must import their energy alongside their
gold, it may appear difficult to keep their balance of payments in the black.
Yet their human capital is strong enough at this juncture to supersede this
difficulty, if only the business environment were improved so that companies
such as Cipla would not move out and instead expand their operations. Foreign
investment also looks unlikely to reverse without a change of policy, as Goldman Sachs downgraded India to underweight and
recommended investors stay selective in that market.
It
is better to have a reasonable import tax, and let business work, so the
government can earn income from it rather than attempting to stop the flow of
gold via exorbitant duties and currency controls. Blocking the free inflow of
gold is a bad symptom of India's economic problems. It can't be a cure.