Will reducing gold imports help the Indian economy?

Nagu43 posted the following comment today, and I thought these are interesting questions that are relevant to today’s economic environment.

I have few questions, haven’t come across post on these topics, Pls share links to post incase I have missed.
What’s wrong with Indian Economy
Why is Indian GDP low than that of other developing countries
Does stopping gold import will improve Indian Economy
Why is rupee depreciation continuing, what would help rupee to gain

These are all big questions and a lot has been already written about them but I think it is worthwhile to look at them again, and today I’m going to take up the question on gold imports, why it is perceived to be bad for the Indian economy, and why they say that reducing gold imports will be better for the economy.

Let’s start at the start.

How do we pay for imports?

The most important thing that India imports is crude oil – we  import crude oil from countries like Saudi Arabia, Iraq, Venezuela etc. and these countries don’t accept the Indian Rupee for payments, they want us to pay them in an internationally accepted currency like the USD or Euro. It would have been great if these countries accepted the Indian Rupee because India can print as many Rupees as they want but India can’t print the USD or the Euro, so we have to rely on other means to get US Dollars.

How do we get US Dollars?

There are three main ways in which India gets USD. The first one is obvious enough, when we export goods and services – we get paid in USD. The second one is also fairly obvious which is investment. When foreign investors invest in India – they bring in USD and that’s another way to get USD.

The third way which is not very apparent is remittances. I did a post some time ago in which we saw that remittances were as much as 46% of India’s total services exports, and this means that NRIs sending in money to India is also a big contributor to foreign exchange reserves.

What do these two things tell us?

These two things tell us that it is absolutely essential for us to have a steady flow of USD or other big currency coming in the country in order to finance our oil bill and pay for our other imports, if we run out of foreign exchange, we will be in big trouble because without oil, nothing else will function.

The measure for whether this equation is fine or not is called CAD (Current Account Deficit), which is largely the difference between exports and imports and in India’s case, the CAD is becoming higher and higher with each successive month, and this means that India’s foreign exchange reserves are diminishing.

One of the big factors worsening India’s CAD are the ever increasing gold imports. The festival of Akshaya Tritiya contributed to heavy imports recently, and that in turned made the CAD even worse. If India spends USD on gold then that reduces the forex reserves for other important commodities like oil.

Theoretically, if there were no gold imports then that would eliminate the burden on forex reserves, and in a way it will help the Indian economy. However, you can’t eliminate gold imports completely because a lot of people depend on gold jewelry and investments for their livelihood, and India has always imported gold.

So, the problem then is not so much gold imports but the great pace at which these imports have increased in recent years, and the pressure it is putting on the foreign exchange reserves, and the worsening CAD.

Will stopping gold imports help the Indian economy?

The answer to this question is simple – no, simply stopping gold imports will not help the Indian economy because a lot of people depend on gold for their livelihood, and they need gold imports to remain in business and survive.

Will slowing down gold imports help – yes I believe they will help because they wouldn’t be such a big drain on our forex reserves and that will be great.

However, the recent rise in gold imports have been investment driven and that is largely due to the rise in gold prices, and a lack of other investment alternatives available to Indians.

Simply increasing duty on gold does nothing to alleviate either of these causes and that won’t do anything to help the economy. What we need is a better investment climate that helps people get other alternates to gold for investment, and that also helps with the other factors that I wrote about above related to bringing in foreign exchange in the country. You want a climate where exports rise (services exports declined last month), foreign investments come into the country – both in the form of FDI and FII, and all that in turns help the CAD.

Conclusion

To conclude, I’d say that what the problem that these huge gold imports cause is a worsening foreign exchange position, and the way to help the foreign exchange reserve is not to increase duty on gold imports to discourage them but attack the root and look for long term solutions to problems lowering exports, FII, FDI flows, and a sluggish stock market.