India increases gold tax third time this year in piecemeal approach to cut deficit and defend rupee

India unveils gold duties in piecemeal approach to defend rupee

7:13am EDT

By Rafael Nam and Swati Bhat

MUMBAI (Reuters) – India raised import taxes on gold and silver on Tuesday as policymakers scrambled to narrow a gaping current account deficit, but concerns about the slowing economy and fears of more capital outflows kept up pressure on the ailing rupee. The rupee got a small lift after the gold measures were announced in late afternoon, after earlier threatening to test record lows.Finance Minister Palaniappan Chidambaram unveiled plans on Monday to curb imports and raise capital inflows to relieve the grinding pressure on emerging Asia’s worst-performing currency.

But the measures have largely underwhelmed investors due to a lack of specific details.

India’s broader aim is to narrow the current account deficit to 3.7 percent of gross domestic product (GDP) in the fiscal year ending in March 2014, down from a record 4.8 percent in the previous fiscal year, Chidambaram told parliament, a goal many analysts said was optimistic.

But market participants fear India’s piecemeal approach of raising a couple billion dollars here and a couple of billion there will not be enough to arrest the rupee’s decline at a time when the economy is weakening and prospects of foreign outflows grow on the back of a rollback in U.S. stimulus.

Without a more ambitious plan to tackle the current account deficit, analysts say the Reserve Bank of India (RBI) may need to stick to its gambit of draining cash from the financial system longer than expected, risking further strains on the economy and, in turn, making it harder to attract vital foreign inflows.

“These measures need to be backed by structural reforms. Unless the fundamental woes are addressed, any sustained relief in the rupee will be temporary,” said Anubhuti Sahay, economist at Standard Chartered Bank in Mumbai.

The rupee recovered somewhat after the announcement of the gold and silver import tax hikes to trade at 61.12 to the dollar. It earlier fell to as low as 61.66 per dollar, not far from the record low of 61.80 hit on August 6. It has lost more than 10 percent so far this year.

ALL THAT GLITTERS

India hiked the import duty on gold to a record 10 percent, the third such increase in eight months, while also raising excise duty on the metal.

Gold is India’s biggest luxury import and was a key contributor to the all-time high in the current account deficit.

The move comes as imports of gold revived to $2.9 billion in July after a series of tax hikes and constraints on supplies had initially appeared to stem demand, confirming the resilience of demand in the world’s biggest buyer of bullion.

Analysts also fear that duties on gold may just increase smuggling.

Cutting oil import bills – another component of Chidambaram’s plans on Monday – may be a tougher task given the weakening rupee is pushing up domestic fuel prices.

India also has yet to provide details about its plans to impose duties on non-essential items, such as electronic goods, which would need to be carried out without breaking World Trade Organization rules.

“This piecemeal and stop-gap approach to addressing a real problem risks backfiring as it undermines investors’ confidence,” said Sonal Verma, economist with Nomura in Mumbai.

LOOKING FOR DOLLARS ABROAD

India also hopes to attract $11 billion in capital inflows by spurring state-run companies such as Indian Railway Finance Corp Ltd to sell debt abroad, and by raising money from Indians abroad, among other measures.

But the fundraising would be done in an uncertain global economic environment, and at a time when growth remains weak.

For example, Indian Oil Corp (IOC.NS: Quote, Profile, Research, Stock Buzz), which is expected to raise $1.7 billion, last month sold 10-year dollar-denominated debt by paying about 50 basis points more over equivalent U.S. Treasuries than in its last sale in July 2011.

Economic data remains discouraging. Figures on Monday showed industrial output declined a larger than expected 2.2 percent in June from a year earlier.

Fears about the U.S. Federal Reserve’s plans to taper back its monetary stimulus have sparked strong foreign selling in many emerging markets, especially in debt. Foreign investors have sold a net $11.6 billion of Indian debt and equities since late May, when the rupee started its decline.

“A strategy to sustainably reduce the current account deficit – the fundamental problem – is missing and the focus remains on garnering more debt inflows to finance the current account deficit,” Nomura said in a note to clients.

“This strategy has already been tried and tested over the last few years and has resulted in the country accumulating larger external liabilities – the price of which is being paid now. More of the same is unlikely to result in a different outcome.”

Even if the government does whittle the current account deficit down to 3.7 percent, it is still above what the RBI has called a sustainable deficit of 2.5 percent of GDP.

 

India Increases Gold Tax Third Time This Year to Cut Deficit

India, the world’s biggest gold user, raised the tax on imports for a third time this year to curtail demand and contain a record current-account deficit that’s weakened the rupee to an all-time low.

The tariffs on gold and platinum imports were increased to 10 percent from 8 percent, while the levy on silver was boosted to 10 percent from 6 percent, the Ministry of Finance said in a notification tabled in parliament today. Taxes on shipments of gold concentrates, ores and dore bars will rise to 8 percent from 6 percent, while the duty on silver dore bars will climb to 7 percent from 3 percent, the ministry said in a statement.

Finance Minister Palaniappan Chidambaram plans to curtail gold imports to 850 metric tons this year to reduce the current-account deficit and boost capital inflows by allowing state-run financial companies to issue “quasi-sovereign” bonds to finance infrastructure investments. The deficit, mainly fueled by crude oil and bullion imports, is the biggest risk to the $1.9 trillion economy, according to the central bank. The rupee fell to a record low of 61.8050 per dollar Aug. 6.

“An increase in taxes will boost local prices and increase smuggling,” said Bachhraj Bamalwa, a director at the All India Gems & Jewellery Trade Federation. “Gold imports may not be more than 150 tons in the July-December period.”

India imported 478 tons in the six months through December last year, taking full-year purchases to 860 tons, according to the World Gold Council. The government also increased the excise duty on refined gold to 9 percent from 7 percent, and that of silver to 8 percent from 4 percent, the ministry said.

Imports Halted

Spot gold fell 0.6 percent to $1,330.09 an ounce at 6:59 p.m. in Mumbai. The metal rebounded 13 percent since reaching a 34-month low of $1,180.50 on June 28. Gold for delivery in October advanced as much as 1.4 percent to 29,333 rupees ($480) per 10 grams on the Multi Commodity Exchange of India Ltd. and was last at 28,990 rupees.

Imports by banks and other traders have come to a standstill after the Reserve Bank of India on July 22 said shippers may supply gold only to the jewelry business and bullion dealers who sell to jewelers. Importers have to retain 20 percent of the gold in bonded warehouses and will be allowed to make fresh purchases only after at least 75 percent of the quantity has been exported, according to the bank.

Metal Shortage

“Government’s intention is to ensure that gold imports are reduced,” said Rajesh Mehta, chairman of Rajesh Exports Ltd. “Once the festival season starts there could be a shortage in the market. With this duty increase more imports from the legitimate channels will get into the illegitimate channel.”

Imports surged 87 percent to 383 tons in the four months through July from 205 tons during the same time a year earlier, Revenue Secretary Sumit Bose said today. Silver shipments jumped three fold to 127.9 billion rupees between April and July from 42.8 billion rupees a year earlier, the ministry said.

Consumption in India, which imports almost all the bullion it needs, accounted for 20 percent of global demand in 2012, according to data from the gold council. Bullion imports were 845 tons in the 12 months ended March 31, while silver shipments totaled 1,963 tons, according to the Ministry of Finance.

Hurting Demand

“The combination of limited imports, as local participants sort through the various regulation changes this year, higher taxes and rupee weakness make gold considerably more expensive, which would in turn hurt demand,” Joni Teves, an analyst at UBS AG in London, said in an e-mailed statement. The tax increase will further raise the incentive for unofficial flows and the government may need to start cracking down, she said.

The current-account deficit, the broadest measure of trade, tracking goods, services and investment income, widened to $87.8 billion, or 4.8 percent of the gross domestic product, in the year ended March 31 from $78.2 billion in 2011-2012, according to official data.

India may generate about $11 billion of inflows and keep the current-account gap at $70 billion, or 3.7 percent of gross domestic product, in the current fiscal year, Chidambaram said yesterday. The increase in taxes on bullion and other commodities may help garner 48.3 billion rupees, Bose said.

To contact the reporters on this story: Swansy Afonso in Mumbai at safonso2@bloomberg.net; Bibhudatta Pradhan in New Delhi at bpradhan@bloomberg.net; Abhijit Roy Chowdhury in New Delhi at achowdhury11@bloomberg.net