InclusionPast IssuesRecipes for Growth

Recipes for Growth

This is the ‘reforms’ party that the United Progressive Alliance (UPA), led by Prime Minister Manmohan Singh, decided to conduct as it entered the latter half of its second tenure at the helm of the country’s affairs. But, while the Government may be certain of the menu it is serving, there are many who have already shown some distaste. They include politicians of different hues, different agendas, and leaders who say that it was a menu that was indifferently cooked and served, and they wonder what the future courses would be like. Consider the three courses that have already been served by the UPA-II Government.


Course 1: Regaining some lost ground from when it had first talked about foreign direct investment (FDI) in multi-brand retail, the Government pushed through a move that will allow 51 per cent in multi-brand retail, probably the only unpalatable dish among its allies. Similarly, it also relaxed rules for FDI in the aviation sector, allowed an increase of foreign direct investment in some broadcasting services from 49 per cent to 75 per cent and disinvestment in four key profit-making public sector units (PSUs). These announcements were preceded by the soup that the Government served when it took the politically tough decision to hike prices of diesel by Rs 5 per litre and also capped the supply of subsidised liquefied petroleum gas cylinders to six per household.
Course 2: Just when political parties had begun digesting the servings of Course 1, the Manmohan Singh-led Government took a number of decisions that left a very sour taste in the mouth of several State Governments, and a large number of political parties, including its allies. The main dish in this course was a Rs 2 trillion package for the financially bleeding state electricity boards, a ‘supposed’ bonanza of ‘one rank one pension’ for ex-servicemen and an increase in dearness allowance for Central Government employees.
Course 3: Everybody was grumbling but nobody seemed to be ready to leave the dining table—except, of course, the Trinamool Congress—and then the UPA Government unveiled its third course, one that appeared certain to cause more upset stomachs. Some among leaders of various parties who thought they should have taken these decisions when they were in power, and among others like the Left parties, who felt that the meals would only serve to fill the stomachs of foreign investors. This, third course, saw the Cabinet giving its approval on hiking the FDI limit in the insurance sector to 49 per cent and throwing open pension funds to foreign investors. It also included amendments to the Competition Act, the Companies Act (Amendment) Bill; the Forward Markets Commission Regulatory Authority (Amendment) Bill; and, a proposal to plug leakage in the public distribution system (PDS).


Menu for Growth

“What we need today is both macro-economic and micro-economic reforms, with measures taken in both areas complementing and supporting each other. Also, reforms in these sectors would necessitate changes in the way Government processes and programmes were designed and implemented.”
Montek Singh Ahluwalia, Deputy Chairman, Planning Commission

Planning Commission Deputy Chairman Montek Singh Ahluwalia recently said, what we need today is both macro-economic and micro-economic reforms, with measures taken in both areas complementing and supporting each other. Also, reforms in these sectors would necessitate changes in the way Government processes and programmes were designed and implemented. “This is really making the ecosystem in which sectoral production, efficiency, growth, dynamism and inclusion can take place.” If inclusive growth has been the agenda and aim of the UPA-II, it needs to bring on the table governance reform, development planning, national security and foreign policy. The highlight of its policy then should be the sustainability of the growth process and strengthening of pluralistic and secular politics. Here sustainability implies fiscal reform, inflation control, public sector reform, efficient and transparent public-private partnerships, a more competitive economy and external economic stability.

An important element of inclusive growth is financial inclusion and this is one area that calls for major reforms in the country’s banking sector. Financial inclusion is especially necessary because empirical evidence seems to suggest that reforms over the last 20 years or so have led to inequalities in the economy. Unfortunately, financial inclusion has not got the attention that it deserves and as a result even the approach paper to the 12th Five-Year plan has not recognised the need for the banking sector to expand or for the micro-finance sector to be revitalised for fixed capital formation. Said Ashok Jha, Chairman of MCX-SX, that as per the 2011 Census, over a 100 million households did not have a bank account, while accounts had been opened for the balance 147 million households. However, this is mere statistical inclusion, because nearly 80 per cent of these accounts are inoperative. This is also amply demonstrated by the fact that even though the Reserve Bank of India has said that overdraft facilities should be given liberally to such account-holders only about 1.5 per cent do actually get such a facility. It is time that the banking space in the country was liberalised, allowing more private players to come in.

If reforms in the banking sector are taken forward, then the country’s small enterprises sector can get much-needed financial support; the sector today accounts for almost 45 per cent of the output of the manufacturing sector, is responsible for about 40 per cent of exports and is the largest employer after agriculture. But this is a sector, which is perennially short of funds. In fact, the fourth census of micro, small and medium enterprises shows that only about 5 per cent of them got finance from institutional sources, 2 per cent from non-institutional sources and the balance 93 per cent had to do without any financing. It is here that the need for strong micro-finance institutions comes in. Over the years, the MFIs have done a splendid job in reaching out to the poor in both urban as well as rural areas. “MFIs have brought banking to the doorsteps of the borrowers, unlike banks which want the borrower to come to their doorstep. Unfortunately, due to malpractices by some lenders, the entire sector has been choked for the last two years as onerous conditions have been placed on their functioning,” Jha added.

This is really making an ecosystem in which sectoral production, efficiency, growth, dynamism and inclusion can take place

Adding a legislative perspective to financial sector reforms, S S Tarapore, Distinguished Fellow, Skoch Development Foundation and former Deputy Governor of the RBI, said that legislative reforms give the framework under which policy can be formulated. It is a two-way thing. “Policy should not violate the legislation and legislation should not hinder alternative policies from being put in place.” Legislation provides for an agreement between the Government and the central bank as to what are the objectives of monetary policy and what are the instruments and this should be put in the public domain under law. “Today, the open market operations of the Government are nothing other than a tool for facilitating its borrowing programme where the Government wants to borrow larger amounts at lower rates. If you say that open market operations have to be the instrument of monetary policy, you have to pass an appropriate legislation,” Tarapore added. In fact, a major banking reform that the Government has been dithering over for some time now is promulgating an Omnibus Banking Regulation Act. Today, there are different act governing the working of different banks: the State Bank of India Act; the Associate Bank Act for State Bank’s subsidiaries; and, the Bank Nationalisation Act. So, how is the system to operate when the law is different for different banks?

“Reforms in the power sector are critical as it is the one, which must grow in order that other sectors may also grow. Coal availability must be assured, land acquisition must become easier and the environmental considerations must be taken care of. If we take care of all these things, capacity creation in the power sector can also improve.”
C Rangarajan, Chairman, Economic Advisory Council to the Prime Minister

One key infrastructure sector where the current UPA Government appears to have taken some steps forward is the power sector. But while there were some helpings in Course 2, the problem is that the major ingredients for reforms in this sector lie with the States. And, this is not the first time that reforms have been initiated in this sector; earlier, we had the two versions of the Accelerated Power Development & Reforms Programme (APDRP) package, which have only partially been implemented. However, the restructuring of loans taken by State power utilities is to be accompanied by concrete and measurable actions to improve their performance. Says C Rangarajan, Chairman, Economic Advisory Council to the Prime Minister, reforms in the power sector are critical as it is the one, which must grow in order that other sectors may grow. “The problems here are very clear, coal availability must be assured, land acquisition must become easier and the environmental considerations must be taken care of. If we take care of all these things, I think capacity creation in the power sector can also improve.” Regulatory clarity can prompt more robust private investment. Thus, policies to boost private-sector investment should start by clarifying the fuel-cost pass-through allowed to power projects using imported coal. The recent outage crisis should be treated as an opportunity for politicians, regulators, utilities and consumers to engage and seek sectoral reforms. It must be remembered that structural challenges of the power sector affect each step of the value chain.

The fourth census of MSMEs shows that only about 5 per cent of them got finance from institutional sources, 2 per cent from non-institutional sources and the balance 93 per cent had to do without any financing

An important link here is improving the effectiveness of Government expenditure. In fact, in this context, Ahluwalia cited the 14 reports of the Second Administrative Reforms Commission, Chaired by Veerappa Moily, and said the Government must consider how many of its recommendations have actually been implemented. Today, most of its recommendations have had little impact, as the system has not been able to break free of the existing politico-administrative collusive network. No doubt, reforms appear to be kicking off. Unless they have a compelling IT infrastructure built around them, we may not be able to speed through such reforms. There are compelling reasons to ensure that the IT infrastructure does not lag behind and provides the full force to the reforms to actually take effect. Today, IT is a meta industry; it is a big enabler of other industries and there cannot be any economic activity without IT being a part of it. Here, the Government must ensure an architecture that is flexible, scalable, keeping the long-term in view, because it has to get into multiple kinds of industries to produce more effective economic activity.

“MFIs have brought banking to the doorsteps of the borrowers, unlike banks which want the borrower to come to their doorstep. Unfortunately, due to malpractices by some lenders, the entire sector has been choked for the last two years as onerous conditions have been placed on their functioning.”
Ashok Jha, Chairman, MCX-SX

More importantly, as Alok Bharadwaj, President – Manufacturers Association of Information Technology (MAIT) and Senior Vice-President, Canon India, puts it, “IT can help create a system that can take reforms in other key sectors like education and health forward. IT can help ensure that government services, education and health services are available to individuals in the way we feel is most efficient and keeping the citizens’ interest in mind.” This is especially important because in the entire hullabaloo over reforms, these are probably the two most important sectors, with the widest impact on the economy that appear to get sidelined. Already, there are several bills on reforms in the education sector that have been stuck in Parliament due to various reasons. In fact, it was in September that the Government’s move to see the passage of the Prohibition of Unfair Practices in Technical Educational Institutions, Medical Educational Institutions and University Bill, 2010; the National Accreditation Regulatory Authority for Higher Educational Institutions Bill, 2010; the National Academic Depository Bill, 2011; and, the Education Tribunal Bills, got stalled due to the uproar over the coalgate scandal. Similarly, eight other important pieces of legislation, including the Foreign Educational Institutions (Regulation of Entry and Operations) Bill, 2010; Universities for Innovation Bill, 2011; and, National Council for Higher Education and Research Bill, 2011, have been pending for long.

It is no secret that a balanced diet is essential to good health, and providing nutritional supplements at our anganwadis critical to addressing the shame of having the most malnourished children in the world

When it comes to the health sector, the challenges it faces today are enormous. Surprisingly, most of these challenges are only there because of the common misconception that the possible solutions may find disfavour with voters or influential power groups. This is clearly evident if we look at the monopoly that a select few have exercised on health manpower planning. The result is a poor focus on the delivery of public health services, which affects the common man. Today, inequalities in healthcare relate to socio-economic status, geography, and gender. Those with the greatest need for healthcare have the greatest difficulty in accessing health services and are least likely to have their health needs met. More importantly, there is inadequate public expenditure on health (just about 5-10 per cent of the GDP) coupled with imbalanced resource allocation among States and the Centre. Also, there appears to be a greater tilt in such expenditure towards urban-based and curative services, suggesting an urban bias and rural disadvantage in access to healthcare.

“IT can help create a system that can take reforms in other key sectors like education and health forward. IT can help ensure that government services, education and health services are available to individuals in the way we feel is most efficient and keeping the citizens’ interest in mind.”
Alok Bharadwaj, President – Manufacturers Association of Information Technology (MAIT) and Senior Vice-President, Canon India

It is no secret that a balanced diet is essential to good health, and providing nutritional supplements at our anganwadis critical to addressing the shame of having the most malnourished children in the world. For progress and growth too, a balanced diet of reforms is necessary. Without proper balanced reforms, it is unlikely that India can continue to surge forwards. This also implies that all sectors have to be pushed forward at the same time. Without roads, there cannot be connectivity and without power, there cannot be manufacturing, and without education there can be no skilled manpower, and the list is endless. And as time and again pointed out, growth is necessary for laying the table for inclusive growth. The guiding philosophy of many a good restaurant is simple: Give guests many good reasons to visit; give more good reasons to come back.

The table has been set. But let not the Prime Minister and the Congress falter in the face of criticism. For there are many more meals to serve and maybe a healthy dose of veggies to complement the meats. For then, and only then, will there be health and wealth in every household. After all, as one wise man did say, the proof of the pudding is in the eating.


Regulating the Regulators

Regulating the regulators appears to be the new mantra that the Central Government is pushing forward in its effort to exercise greater control over the country’s stock mart, insurance, commodities market and pension funds. What, however, is unclear is how does it hope to empower this single regulator.

It was on 1st October that the Financial Sector Legislative Reforms Commission (FSLRC), headed by Justice B N Srikrishna, released an approach paper proposing a single regulator called the Unified Financial Agency (UFA) for the financial sector, which would subsume the functions of existing regulators like the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority, the Pension Fund Regulatory and Development Authority and the Forward Markets Commission (FMC).

However, while the approach paper clearly outlines the need for greater accountability for the regulatory process, there is little it talks about how such autonomy will flow to the system. The approach paper has suggested the need for a single regulator on the grounds that it would help achieve competitive neutrality as the boundaries between products and institutions are disappearing. More importantly, it argues that this would improve the accountability of regulation.

“Today, the open market operations of the Government are nothing other than a tool for facilitating its borrowing programme where the Government wants to borrow larger amounts at lower rates. If you say that open market operations have to be the instrument of monetary policy you have to pass an appropriate legislation.”
S S Tarapore, Distinguished Fellow, Skoch Development Foundation

But as global experience shows, the idea of a single regulator is yet to pick up pace, with only two major economies – the UK and Japan – being among the 15-odd countries that have one. Domain experts say that a single regulator might not be able to differentiate between different types of institutions and products. Also, creating a regulatory monopoly could see it functioning in a more rigid and bureaucratic manner, resulting in diseconomies of scale. And, scale is certainly a problem in the Indian regulatory landscape as there is little connect between the existing regulatory agencies and the public at large. Thus, there is little regulatory presence in centres other than the four metros and neither is there an effective IT infrastructure that can enable one to do away with physical presence.

Also, creating a unified regulatory agency will require new legislation, leading to the possibility that the process may be exploited by special interests. It was tackle the emergence of special interests that the Deepak Parekh Advisory Group on Securities Market Regulation (2001) recommended that a system needs to be devised to allow designated functionaries to share specified market information on a routine and automatic basis. Such a system can be devised for the different regulatory bodies we have and avoid the need for creating an entirely new system that as the Srikrishna Committee noted would take at least 10 years to set up.

The issue of choosing between single and multiple regulators in India was raised for the first time by Y V Reddy in May 2001. However, even he did not recommend a super regulator, preferring instead to opt for an umbrella regulatory legislation, which creates an apex regulatory authority, without disturbing the jurisdiction of the existing regulators. What he appeared to favour was regulatory co-ordination rather than unified supervision. Regulation in India is by and large on institutional lines and institutions essentially report to a single regulator.

The issue on hand is who should regulate companies or products that fall between two sectors or fall under more than one sector? There is a feeling among industry players that a unified approach will never work in India as it will create more bureaucratic hurdles. In fact, some even point out that it may become yet another place for retiring bureaucrats and civil servants to park themselves. They also point to the fact that the concerns over ‘regulatory arbitrage’, where institutions create products that fall outside the purview of any single regulator can best be tackled by ensuring that the relevant product is regulated under the industry it falls in and not the sector that its introducer is in. Thus, a mutual fund is performing bank-like functions then it must be subject to the same kind of regulation. And, if there is a product that comes under multiple sectors, an umbrella regulatory body could do the needful.

The present regulatory architecture consists of multiple regulators for banks, pensions, insurance, commodities and securities. Proponents of the single regulatory body argue that as more complex products and services are introduced, a single agency can help prevent any turf war between different regulatory bodies. But, the moot point here is do we have the necessary skill-set to have one super regulator.


21 Decisions, 1 Cabinet Meeting; Reforms In-Situ

In 1991, Finance Minister of the Narsimha Rao led Government, Manmohan Singh architected reforms version 1.0 addressing issues of inefficiencies and protectionism, resulted in catalysing entrepreneurship generating, employment and increasing income across India’s socio-economic pyramid. As a result, the Indian economy has been galloping ever since, securing a seat in the list of BRIC nations, the breakout or emerging economies, call them what you will; India has arrived.

However, despite the growth in the past two decades, certain licensed sectors demonstrate exclusion. Sample this, despite India’s insurance industry, comprising 24 companies in the life insurance business and 27 in the general insurance category, the penetration of insurance cover is a mere 4.4 per cent in life and 0.71 per cent in the non-life business, respectively. As far as the pension sector goes, a mere 12 per cent of India’s working population has some form of retirement benefits. Despite having 80,500 bank branches spread across the length and breadth of the country, only 5 per ent of India’s over 600,000 villages have a bank branch. The task of inclusive growth is indeed herculean and the challenges infinite.

Socio-economic inclusion and inclusive growth are the cornerstones of the incumbent United Progressive Alliance (UPA) government’s manifesto. Just as hackneyed reports and done-to-death discussions highlighting corruption in telecom and coal, non-performance, ensuing policy paralysis, weakening rupee, falling stock indices and the threat of downgrades by global credit rating agencies were peaking, some adrenalin has rushed into the economy, the investment sentiment booming, with the Sensex hitting a 18-month high, and the rupee strengthening against the dollar by a massive 10 per cent. Phew!

Prime Minister Manmohan Singh and Finance Minister P Chidambaram recently unleased version 2.0 of the reforms, which began with taming fiscal indiscipline, including shaving of subsidies on fossil fuels by hiking diesel prices and limiting supply of subsidised domestic cooking gas to six cylinders per annum, sending out the message that the Government would no longer compromise on fiscal stability, upping FDI in the insurance sector from 26 per cent to 49 per cent, allowing overseas investors to own up to 49 per cent stake in domestic pension fund managers, and enabling multinationals to have 49 per cent stake in multi-brand retailing. The Government also approved multiple legislative proposals, including the new Companies Bill; amendments to the Competition Act; and, Forward Contracts (Regulation) Act.

Global rating agencies like Fitch, S&P and Moody’s have all hailed the Government’s reforms initiatives but await evidence of implementation of the measures on the ground and how the economy reacts. While the Government has demonstrated gall and courage, is the Industry excited?

A Prime Minister’s Office Tweet soon after reforms 2.0 were announced reads: “The Cabinet has taken many decisions today to bolster economic growth and make India a more attractive destination for foreign investment. I believe that these steps will help strengthen our growth process and generate employment in these difficult times. I urge all segments of public opinion to support the steps we have taken in national interest.”

While more reforms lie ahead in the sphere of infrastructure, change of tax regimes (including the draconian retrospective General Anti-Avoidance Rules (GAAR), and financial services, including implementation of the Goods and Services Tax (GST).The key concern for the Government is now the passage of these bills in Parliament, with a fractured opposition ambiguously stating reservation and publicising their intent on offering substantial resistance.

Global rating agencies like Fitch, S&P and Moody’s have all hailed the Government’s reforms initiatives but await evidence of implementation of the measures on the ground and how the economy reacts. While the Government has demonstrated gall and courage, is the Industry excited? Or will they still love to continue fence sitting? The need now is for urgent stakeholder participation from farming to manufacturing and services to execute the second generation of reforms that ought to bring the economy back on the 9 per cent growth path.

Well, India Inc is welcoming and defending the reforms process, urging the Government not to give in to opposition.

Anand Mahindra, Chairman, Mahindra & Mahindra, tweeted: “Again, we urge the Government to stand its ground. Right-thinking Indians will be less than amused by partisan politics in a fragile economy.”

Anil Agarwal, Chairman, Vedanta Resource“Global investors are looking for stability to invest in India, as the country remains a top choice for them. Government’s reforms have created inflows.”

Adi Godrej, President, Confederation of Indian Industry (CII):“I am glad that we are increasing FDI in insurance and that we are bringing in FDI in pension plans. Opening up FDI will ensure long-term investment. This is a positive move, in keeping with the fact that we need large investments in infrastructure in the next five-year plan.”

Dhirendra Swarup, Former Chairman, Pension Fund Regulatory and Development Authority (PFRDA): “The move will bring in greater fund management expertise and will bring in competition. The consumer is going to gain to a large extent.”

R V Kanoria, President, Federation of Indian Chambers of Commerce and Industry (FICCI): “The country needs reforms, it needs to grow, it has potential, talent and entrepreneurial skills. I will urge those who are not supporting the reforms to think carefully.”

On Facebook, Mamata Banerjee posted: “Sometimes speech is silver and silence is golden. We are not party to it. We are not supporting these anti-people decisions. We are very much serious about these developments and ready to take hard decisions if these issues are not reconsidered. In a democratic set-up, reforms must reach the poor and common people and the beauty of democracy lies on realising its responsibility towards the common people.” India’s youth have just ‘un-friended’ her.
Vibhu Arya is an independent financial inclusion consultant.


Taxing the Losers to Benefit the Gainers

Taxing transactions that result in losses is not something that any Government would like to do. And, increasing the tax rates on such transactions is something that no Government would want to be associated with. But if the Parthasarathi Shome Committee’s recommendations are anything to go by, the Government should increase the securities transaction tax, irrespective of whether an investor is making money or losing it.

This is even as the former IMF economist has recommended that the Government do away with any tax on short-term capital gains, an area where every investor is actually making a profit, with the amount too being significantly less than what the Government earns through the STT. His logic: it will boost investments by both global and domestic fund houses. But in the process, Shome is asking retail investors and traders to bear increased costs.

Today, short-term capital gains on listed securities are taxed at a rate of 10-30 per cent (depending on the class of investors) in case of ‘gain’ or profits on transaction squared off within a year, STT is a tax levied on every transaction, irrespective of it being profitable or one that results in a loss. Also, STT is applicable to the gross value of a transaction and not on the resulting profit or loss.

The Shome Committee’s primary argument for doing away with the capital gains tax was that the Indian tax authorities would no longer have to worry as to how foreign investors and non-resident investors characterised their profits – most avoided paying tax by not being registered in the country. The aim was to make it more attractive for foreign investors to operate directly out of India, rather than route investments to countries that do not levy any tax on capital gains.

However, as leading market players observe, this is one tax that will certainly drive down volumes in the cash market, which today account for less than 15 per cent of the volume on the stock exchanges. This is because any increase in transaction cost is certain to lead to some decline in volumes. On its part, the Securities and Exchange Board of India too has called for tax to be kept at levels which would incentivise people to make investments for the long-term. Shortly after the Shome Committee submitted its report, SEBI Chairman U K Sinha was quoted as saying that the STT rate was rather high now and “it should be used in a manner that people (investors) are incentivised to invest for the long term rather than for the short term (speculation).”

As Benjamin Franklin famously said, “in this world nothing can be said to be certain, except death and taxes”. In 1789, Franklin was talking in the context of the freshly minted US constitution, which everyone expected to ‘promise permanency’, but the quote has taken a life of its own as a statement about the inevitability of taxes.

Right from its introduction, STT collections have been robust and growing, with two exceptions – in 2008 and 2011-12 when the collections declined. For the current year, the STT collection has been pegged at Rs 70 billion, an amount that is not insignificant in the overall revenue budget. And it is a collection of just Rs 30 billion – an amount the Shome Committee notes as being the small-term capital gains mop-up—that the STT should be increased to make up for.

When financial markets are functioning well, capital is put to its most productive use. The opportunity set available to firms and households expands, resulting in higher growth rates and more inclusion. Thus, financial markets work as enablers with a multiplier effect on the economy. By taxing financial transactions of any kind, we reduce the efficiency of price discovery in these markets, which in turn delays the processes of adjustments to changes in demand and supply. These taxes are especially problematic when they prevent arbitrage between different markets.

An important natural experiment in the impact of STT has been the relationship between STT and the options market. Today, NIFTY options are one of the most active contracts globally. However, before 2006, there was very little liquidity in this contract, as STT was being charged on strike price plus premium, making the STT the largest element in the contract. The reduction of STT on options allowed this market to develop, and consequently allowed the creation of structured product offerings that used these options for hedging. Like all other taxes, taxes on financial transactions tend to distort economic decision making.

The application of STT in India has also created distortions because it is not uniformly applicable across all asset classes. Traders’ decision to provide liquidity in a particular asset class is based on the overall costs of trading that asset. We need to find ways to improve governance and manage systemic risks, but at the same time, we need to keep transaction costs within manageable levels. Only then will financial institutions be able to make full use of markets to provide the products and services that are required by a fast maturing economy. Removal of STT alone may not have a significant long-term effect, though it is likely to improve optimism and provide a boost to markets. Removal of STT is a low hanging fruit, and must remain high on the policy agenda.

Tap the Bullion Market, don’t Push it Underground

Open market, this is what the UPA Government has been seeking to promote. But the left hand knows not what the right does! Andin one stroke, the Government has succeeded in giving boost to an industry that it was seeking to wipe out. Gold smuggling is yet again becoming the lucrative business that it was 20 years earlier!

It was in the Union Budget 2012-13 that the Government sought to check gold imports by doubling the customs duty of 2 per cent on standard gold. Earlier in January, the Government had imposed a 2 per cent. The Government argued that this was necessary as the sharp increase in gold imports was widening the current account deficit, it is an unproductive asset, prevents more productive savings and it is a drain on foreign exchange.

For people who see gold as an instrument of saving and one of luxury, the Government’s moves could not have come at a more difficult time: the stock market is one market they know little about and is not easily accessible, and economic and agriculture growth are yet regain their momentum. For most of India’s working class, gold is an asset that is not merely a consumption good, but one that gave them financial security. In fact, it enabled them to channelise their savings in the absence other financial products, like even basic banking infrastructure. More importantly, in times of high inflation, as was seen recently, gold is seen as the perfect hedge.

But interestingly, the four-fold hike in custom duty seems to be going against the very spirit with which the Gold Act was abolished in 1992, i.e., curtailing gold smuggling. If recent reports are any indication, gold seizures at domestic airports have risen by almost 10-fold in the months following import duty hike, indicating a rise in the grey market for gold. Even data from the Finance Ministry points out that between April and June this year, the customs authorities seized 200 cases of smuggled gold worth $169 million Rs (Rs 9.4 billion), up by 272 per cent as compared to seizures of $46 million (Rs 2.4 billion) in the previous year.

Moreover, in the period when smuggling increased, data from the World Gold Council showed that India’s gold imports declined due to the impact of higher duties and rising prices. But, if one looks at the reported seizures by official agencies, it is unlikely that gold arrivals have declined. What this means is that the rise in illegal gold imports does not imply any slump in demand but only causes losses to the state exchequer.

More importantly, with the festive season round the corner, India’s rush for gold is likely to see some improvements despite the poor monsoons and the weak economy. Also, with the recent improvements in the rupee, gold is suddenly becoming attractive again.

Thus, in every sense, hike in duty is not resolving the problems that the Government aimed for; instead, it is encouraging the rise in illegal smuggling of gold, building up organised crime and moreover leading to heavy duty losses, both in terms of smuggled gold and concealing of black money. The solution instead lies in other policy measures be looked into from a different perspective. In this context, the Government could introduce some innovative gold-based products, such as gold bonds. Such bonds would enable the Government to monetise the vast stockpiles estimated to be worth $950 billlon being held by Indian households. Further, with prices now prevailing at a fairly high level, the new-found interest of Indians towards gold as an asset class (as against jewellery demand) and given the need for gold as a financial asset from both investors and economy’s point of view, its time to launch some gold-baseds product in the markets. Such a shift in the market preference for is evident, if one looks at the WGC’s figures for consumer demand for gold in 2011: consumer demand in value terms for 2011 rose by a robust 31 per cent for bars and coins in contrast to just 8 per cent for jewellery, a clear shift in the reason for which money was coming into gold. Such innovative products need to be encouraged in India by allowing market participants to structure and offer various combinations. Overall, the thrust should be on augmenting the array of financial products that appeal and are conveniently accessible by investors across both urban and rural areas.

As C Rangarajan, Chairman of the Prime Minister’s Economic Advisory Council, suggested in a report in February this year that the “best means of limiting the appetite for gold is to work towards making other kinds of assets more attractive….”

Team Inclusion

INCLUSION is the first and only journal in the country that champions the cause of social, financial and digital inclusion. With a discernable and ever- increasing readership, the quarterly relentlessly pursues the three inclusions through its rich content comprising analysis, reportage, features, interviews, grassroots case studies and columns by domain experts. The magazine caters to top decision makers, academia, civil society, policy makers and industry captains across banking, financial services and insurance.
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