Gold: Will you feel the pinch of the new custom duty?

Halfway through January 2012, the government unexpectedly announced a change in the structure of gold's import duties. In the midst of one of the coldest winters in India, we're letting you in on how this new revision will affect your gold investments: Will it bring warmth to your gold holding? Or will you have to burrow your hands deeper into your pockets?

The Call of Duty

In a bid to match the import duty with rising prices, the government trebled the customs duty on import of gold by increasing the duty twice by Rs. 100 each time, during the Fiscal Year 2009-10.

On 17th January 2012 the government again changed the import duty and it has been set at 2% of value from the earlier import duty of flat Rs 300 per 10 grams. This means, at current price of Rs. 27,700 (rounded-off current gold price) for 10 grams of gold, while you used to pay Rs. 300 as customs duty, it will now increase to Rs.560 (approximately) per 10 grams. In other words, customs duty which amounted to 1.08% at current prices has increased to 2% of value; nearly double of the tariff.

What made the government raise the import duty on gold again? Here are a few probable reasons...

One, India is the world's largest consumer of gold and most of the gold demand is satisfied through imports. As consumption of gold increased, the value of gold imports also saw a rise. We know that higher imports require higher foreign exchange to pay for the import bill, causing a strain on the country's trade balances. Higher imports and rising gold prices worsened the rising trade deficit issue. As per December 2011 data, gold and silver imports grew at 53.8% to $45.5 billion. (Source: Cybex.in)

Many blamed gold imports for rising deficit and the resultant sharp depreciation of the Rupee compelling the government to take immediate measures concerning gold import. However, they simply tend to ignore that this allocation to gold helped the investor's portfolio during the year (2011) when most of the other assets lost heavily.

On the other hand, the increase in duty becomes an additional revenue source for the government. Everyone is aware that the governemnt is struggling to keep deficit under control and is unlikely to meet its deficit targets. This may prove to be a useful contribution for government finances at the expense of gold buyers. According to estimates of the World Gold Council, the Indian government earned around Rs 2,836.6 Crore from import duty on gold after the Budget decision in 2010.

This move will probably ease the pressure that the Rupee has been facing and help increase revenue collection from duties.

The Impact on the Investor

Existing investors of gold will benefit from the hike in import duty as the value of the gold owned by them has increased by approximately 1% (other things being equal). On the other hand, prospective investors who wish to buy gold will probably have to purchase it at a higher rate to the extent of increase in the duty.

The import duty adds an additional levy of approximately 1% of the current market value. As mentioned in the table below, if you add this with existing duties and levies, the price difference between internationally sourced gold and Indian domestic gold widens to nearly 3%. This indicates that the Indian consumer is paying 3% more than the price of gold in the international markets.

The increase in duty is unlikely to impact the demand for gold in any meaningful way. After each of the previous episodes of duty hikes, duties/taxes as a percentage of gold's price would increase to nearly 3% of gold's price. This time, the increase has moved up close to 3% but it is not likely to affect the demand for gold as seen after the previous tariff hikes.

Post this increase as well, we have seen the duties/taxes total to 3.3% of gold price and hence should not influence gold's demand in any manner; atleast beyond the short term. Also, the sharp increases in price has not really made much difference in the demand suggesting that a 1% increase in duty should not impact the sentiment of purchasing gold.

By Chirag Mehta, Fund Manager, Commodities, Quantum Asset Management Company Private Limited.

For complete report click on the attachment.

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