Stop lusting for gold, brace for diesel hike: Rangarajan

Rising gold imports has had a severe impact on India's balance of payment with current account deficit (CAD) rising to 4.6 percent in the first half of current fiscal. Alarmed by the situation, finance minister P Chidambaram curtly told importers that import duties will be hiked to clamp down on massive inflows of gold. This will be the third hike in a year.

Speaking to CNBC-TV18, Prime Minister's Economic Advisor C Rangarajan said gold imports are running much above the average seen in previous years and a hike in import duty of gold will help reduce the CAD. He sees gold imports coming down once inflation is contained. "Gold is long seen as a commodity to hedge against price rise. Apart from gold, oil and petro imports are also impacting CAD," Rangarajan added.
Despite widening of current account deficit, Rangarajan sees rupee stable at around 54/55; he also told CNBC TV18 that fiscal deficit can't be met unless diesel prices are raised. Below is an edited transcript of the interview on CNBC-TV18. Q: The gold report from the Reserve Bank of India indicates that monitoring of gold will become inevitable and important to manage the current account deficit which is now reaching destabilizing levels. The report recommends fiscal initiatives such as the probable imposition of a higher import duty and has vaguely hinted, but not explicitly suggested, a sales tax and capital gains tax (CGT). What is your opinion on the extent of the gold menace and the fiscal initiatives suggested by the report?
A: Gold imports have been running at a level much above the average seen in the previous years. Therefore, certainly gold imports are contributing to the decline in the balance-of-payments (BoP) situation. Therefore, the question is how to exactly handle this problem.
To some extent the increase in the gold imports is also due to the high level of inflation in the country. Many people seem to regard gold as a hedge against inflation. Therefore, a part of the reason for the high level of imports is the high level of inflation seen in the recent period.
Therefore, one way of fighting gold imports is also a fight against inflation. If inflation rates start coming down, I expect gold imports to also come down. Q: What is your worry about current account deficit itself? Are you worried that this current account deficit could be a problem that will overwhelm us? At the moment there is a risk on globally and India and other emerging markets have received a lot of money which has bridged the current account deficit. Will we be as lucky as in all the quarters of FY14 or could something drastic happen if for a quarter or two there were no inflows for?
A: There are two related problems. One, is about the current account deficit itself and the other is about financing the current account deficit.
First, let us look at the current account deficit. Gold is one element but there are other elements in the picture which also need to be looked at. Import of oil and petroleum- related products has been a significant proportion of total imports.
_PAGEBREAK_
However, if you look at the performance in the last one year, non-oil, non-gold imports have not really gone up that much. In fact, there is a decline. Therefore, a part of the problem is the persistence of high-level of imports of oil and the oil prices not coming down as one expected because of the slowdown and the high level of gold imports.
Second, on the export side, we should not linearly project what has happened in the first two quarters. In the first two quarters or the first half of last year, exports rose by 42 percent. Therefore the performance of the export sector as in comparison to last year has not been very encouraging. In fact, there has been a decline in the growth rate.
But in the next two quarters, that is Q3 and Q4, exports may do somewhat better. Therefore, we need to address both issues namely: raising the level of exports. Therefore, if we can diversify our exports more in terms of the fast, better growing economies in Asia and other countries, then probably we can move to a better export situation.
As far as imports are concerned, certainly oil imports remain high and we really need to do something about expanding the domestic production, both oil and gas and our policy environment must be supportive of that. Therefore, I think during the current year, the current account deficit maybe more or less the level that we saw last year at 4.2 percent of the GDP and it could even be slightly higher. But this is not certainly a sustainable level of current account deficit.
On the financing of the current account deficit, so far we have had no problems in financing the current account deficit despite the rising deficit both in absolute terms and as a proportion of the GDP. The capital flows have been adequate to cover the current account deficit. But this order of capital flows may not necessarily be available always.
While for the year as a whole the capital inflows maybe adequate to cover the current account deficit, they may not be steady. There could be periods when there could be a mismatch between current account deficit and capital flows and that is when the pressure on the rupee develops. Q: There is uncertainty with regards to the continuation and sustainability of capital inflows. So in 2013 where exactly would you see the rupee in terms of a downside potential? Do you think it could breach that 57 as in 2012 and further depreciate? Or do you think the current levels of 53-55 can be sustained?
A: I think it will be possible to sustain the current levels because I do not see, at the present, capital flows not being adequate to cover the CAD. Therefore, the problem is not going to be over the year. There could be periods in which – as I mentioned earlier - a mismatch arises  between the inflow of capital and the CAD which could add pressure on the rupee. But taking the year as a whole, I estimate capital flows to more or less to cover the CAD. So the rupee could staying more or less at current levels. Q: What are your exact views on the fiscal initiatives the report has recommended on gold? The report hints at levying capital gains and sales tax on gold to ensure a paper trail and bringing gold as an asset class on par with other capital assets. Is that a feasible solution and what is the way forward? Despite the risk of driving the gold market underground should import duties be increased?
A: An increase in import duty is one way of trying to restrain demand. But remember that the price of gold in the international market has not shown any steep increase and has remained at the same level. But in rupee terms, the price of gold has gone up because of the depreciation of the rupee.
But despite the rise in the price of gold in rupee terms, the demand does not seem to have been come down. But nevertheless, I still think that fiscal initiatives maybe appropriate, but they have to be implemented very carefully. We need to calibrate it in such a way that it does not result in an increase in the smuggling of gold. I think we need to be very careful about fixing the level of duty or tax on gold. Q: A lot of economists have pointed out the divergent trend between the wholesale price index (WPI) data and the consumer price index (CPI) data. What are your views with regards to the divergent trend between both these data and which one would you think would take precedent as a concern for the RBI going forward?
A: The reason for the divergence between the WPI and the CPI is largely because of the weight food articles carry in the two indices. Food articles carry a much heavier weight in the CPI index. Recently, food inflation, which is not necessarily food grain inflation, has been rising.
Currently, retail prices are up because of rising food inflation. Obviously, the central bank must look at both the wholesale price index and the retail price index. But I think policymakers would also look at non-food manufacturing inflation, as proxy or as an indicator of the demand pressure in the system.
As far as monetary policy is concerned, policy-makers should look at not only headline inflation with respect to wholesale price index and retail price index, but also non-food manufacturing inflation. Q: You are known to have fought inflation during your stint at RBI. So even by your exacting standards do you think that the non-food inflation is at a level where the monetary authority can relent and push growth with a cut in rates?
A: I would say that there have been some indications that the non-food manufacturing inflation has shown signs of decline. I would like to observe one more data point before reaching a definitive conclusion. If I am satisfied then at least that part of the inflation picture is reassuring, then perhaps there is scope. Q: But given the way in which the commodity prices might shape up this year globally, there is a nascent recovery both in emerging markets and to some extent even in the US, and the trimming of fiscal pressures, do you think there is a leeway of say a 100-bps cut through 2013 or will the monetary authority be much more circumspect and measured in its rate-cuts?
A: I think it is very difficult to forecast what the order of the rate-cut will be during the whole year. So much depends upon how inflation behaves. But one can expect a certain easing during the year, but the extent of that will depend upon a whole set of domestic and external factors. Q: Would you agree that there is a certain helplessness in terms of policy being able to handle the rising demand for gold?
A: The point is that, a certain amount of gold demand is built in to the psyche of the Indian mind. Therefore, we must expect that a certain amount of import of gold will happen. All that we need to talk about is the excess or the additional import of gold in the recent period. I don’t have the numbers regarding the quantity import of gold this year. But last year it was something like USD 66 billion worth of gold.
Now, that is in excess of about USD 20 billion worth of gold over the previous average. It is that which we must really attack. Therefore, it is possible in my view to contain the demand for gold if you offer attractive rate of returns on financial assets in relation to inflation.
I don't think inflation is a medium-term phenomenon. I think control of inflation in the short-term period is also possible and will have a significant effect on the demand for gold. Q: The government had issued measures to recycle gold with products like gold bonds, that invited people to deposit their gold at a bank or a NBFC for some period of lock-in and the return is probably tax-incentivised. Do these products succeed? What has been your experience? What is your opinion as a policymaker?
A: We have not really experimented with it in any big way. And I do not think that given the present psychology of the Indian people, there will be an overwhelming response to any such scheme where they have to part with gold. I think the real answer lies in giving a rate of return on financial products which is more attractive. Gold has such a impact on the people that it is going to be very difficult to make them part with it. Q: What is your estimate of the fiscal deficit and the level we could end the year with as well your view on the 10-year bonds?
A: I think all efforts will be made to contain the fiscal deficit at 5.3 percent of the GDP. As you know the original number indicated in the Budget was 5.1 percent of the GDP. After looking at the development, the finance minister has said that probably the deficit could be 5.3 percent of GDP.
I believe that all effort will be made to contain the fiscal deficit at that level. Some steps have already been taken in order to reduce subsidies. The effort will now be to see that other expenditure, wherever possible, would be contained at the Budget-level so that the overall target can be achieved. I still believe that it is possible to get the fiscal deficit down to 5.3 percent. Q: Will it be politically possible for the government to implement the proposal of a Re 1 increase in diesel prices for the next 6-to-10 months until the under-recovery is wiped out?
A: I do not see how the finance minister can balance the Budget and achieve the fiscal deficit either in the current or next year without adjusting the diesel prices. It is a matter of either convenience or judgement to decide the raising the diesel prices in discrete steps or a continuous manner. But the adjustment of the diesel prices has become imperative.