Budget 2023: Will gold ETFs get more glitter?

Nirmala Sitharaman, Narendra Modi, Budget 2023

February 1 is around the corner and all eyes are on the Budget. Just like every year, everyone is hoping for reforms that would boost India’s development and growth trajectory. So is the gold industry.

To recap, in the Union Budget of 2022-23, Finance Minister Nirmala Sitharaman disappointed the gold market by skipping a reduction of the import duty on the metal.

This was followed by the outbreak of the Russia-Ukraine war, which drove oil prices to highs of $140 per barrel. Logically, this inflated India’s import bill as we import most of our crude requirements and pressured the rupee-dollar rate down from 74.5 to 77 in a couple of weeks.

Domestic inflation started to inch up and citizens naturally flocked to the store of value they know best -- gold -- as they faced negative real deposit rates, a depreciating currency and uncertainty in the economy.

Gold imports, which are the second largest after oil, surged in Q1FY2022-23.

Duty hike

Battling the surging current account deficit, the government hiked the basic import duty on gold from 7.5 percent to 12.5 percent in July in a bid to temper imports and ease pressure on the domestic currency. This effectively increased the difference between the international gold price and landed price of gold in India to about 18 percent, taking into account the Agriculture and Infrastructure development cess of 2.5 percent and Goods and Services Tax of 3 percent.

Immediately following the step, domestic gold prices saw an up-move. Later in the year, anecdotal evidence suggests that illicit gold imports may have risen as the large gap between domestic and international prices created lucrative margins.

As per some reports, upwards of 3000 kg of smuggled gold was seized in 2022, up from ~2400 kg in 2021, a 25 percent increase. Not only has this resulted in price distortions in the domestic market but has also cost the government in terms of lower duty and GST revenue.

Higher government intervention through higher custom duty has over the years ensured that India, despite being the world’s second largest consumer of gold, importing 800-900 tons annually, is a price taker.

Global prices

International gold prices are used to set the domestic gold price in India. The international gold price is used as a base price and converted to Indian rupees using the dollar/rupee rate and we add to it various Indian duties and levies to arrive at the Indian gold price.

Price distortions also make it difficult to channelize the hoard of India’s gold savings into circulation and thereby integrate the gold market with other financial markets.

Duty rationalization has been a longstanding demand of the bullion industry that can help bring domestic gold prices closer to international prices to the extent of reduction in levy and enable more efficient functioning of the gold markets in India.

Promises of the past

We are hopeful that with this Budget, the finance minister will undo the harsh measures and put the industry back on the track of reforms as envisaged by herself during the 2021 Budget and the previous BJP-led government, in office from 1999-2004. Revisiting the budget speeches on gold from that time provide insights into the government’s commitment towards the development of the gold market.

-  2001-2002: “In order to discourage smuggling I propose to reduce the duty on gold from Rs 400 per 10 grams to Rs 250 per 10 grams.”- Yashwant Sinha

-  2003-2004: “As for gold, it is proposed to reduce the customs duty on imported gold to Rs.100 per 10 grams from the present level of Rs.250 per 10 grams, but only when it is brought in the form of serially numbered bars, or in the form of gold coins, not as ‘tola’ bars, please. It is my hope and expectation that this will become the first step in enabling India to shortly emerge as the gold-trading capital of the world.”- Jaswant Singh

Where has the dream of making India the gold-trading capital of the world vanished? Will increasing the duty on gold now not lead to smuggling?

Wish list

Next in the wish list would be a preferential tax treatment to financial gold offerings like Gold ETFs and Mutual funds that invest 90 percent or more of their corpus in units of Gold ETFs will promote the category as an investment avenue over other fiscally inefficient avenues like physical gold and jewellery. This can be done in two ways.

Either Long Term Capital Gains (for a holding period of more than 3 years) be taxed at a 0 percent or maximum 10 percent instead of the existing 20 percent with indexation benefit; or a period of holding to avail LTCG taxation be reduced to 1 year from the existing 3 years.

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By introducing Gold ETFs in 2005-2006, the then Finance Minister took a step forward and enabled investors to buy and own gold more efficiently. The category now needs a further push to take forward the government’s agenda of discouraging savings and investments in physical gold/jewellery and giving a push to the financialization of gold holdings.

According to data from the Association of Mutual Funds in India, the number of gold ETF folios have gone up from ~3.5 lakh to ~46.4 lakh between December 2019 and December 2022. The net assets under management in the same period have moved up from ~Rs 5,800 crore to upwards of Rs 21,000 crore.

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The numbers suggest that investors are warming up to this efficient avenue of gold investing, but it wouldn’t hurt to make the deal sweeter for them, will it?

On that note, here’s looking forward to a Budget that will add the glitter back to gold.