Gold import menace and e-Gold as a solution

(Question #1) In the e-Gold method the investor is able to buy the electronic form of gold. But how can a investor sell the physical form of gold or purchase a physical form of gold in NSEL without electronic gold?

Why gold import is a menace? Yes. The main issue is the loss of forex

Traditionally gold was considered to be the asset world wide.After renaissance, industrialisation, modernization etc. people are not considering gold as important form of wealth anymore.

However, in India preference for gold still persists. There are various social reasons for that: Immovable asset is inherited by the male while the girl child is given her share in the form of gold, jewellery etc. So the problem is on the one hand, there is and will be demand for gold. And on the other hand gold imports are causing serious problem to the economy

Let us understand the problems caused by gold imports to the economy. The main impact is on the forex front. Gold imports take a major share of our forex earnings. Thus, it preempts valuable foreign exchange which will be used for other important purposes. Since it affects the productive capacity, the ultimate effect will be many a times the original impact. The impact of forex diversion will have multiplier effect The actual route will be like this: We import gold instead of machinery. Because of this in the second round, import of consumer goods will be more ( because we could not augement our production capacity at home). Say this year with the available foreign exchange, you import gold instead of machinery. What will be impact of this move in the next year? If you have bought machinery, you would produce the goods locally and you need not import them any more. Since you have imported gold, you could not augment production capacity at home / produce the goods loclly / have to import more.  The cycle will go on and on. Thus control of gold imports is essential. Since you have imported gold, you could not augment production capacity at home / produce the goods locally / have to import more.

Generally, for restricting any imports we have two broad methods - quota and tariff.

1.       Here the first one is a modified quota system.

It allows for import of gold, if the importer can export at least 20% of it back. The main problem with the quota system is administrative difficulty. The problem with 80:20 is physical verification and ensuring that the exports and imports are matching- It is cumbersome. Leads to corruption etc.

2.       So the next alternative is tariff

What is the tariff imposed on gold imports now? It is 10 percent of the value of imports. The government today raised import tariff value on gold to USD 385 per 10 grams and silver to USD 543 per kg, taking cues from firm global price trends. During the last fortnight of March, the tariff value on imported gold was USD 375 per 10 grams and on silver at USD 512 per kg.

The import tariff value is the base price at which customs duty is determined to prevent under-invoicing. It is revised on a fortnightly basis taking into account global prices. For the purpose of calculating import tax, the value of gold will be taken as USD 385 per 10 grams. And you cannot claim that I bought gold for say 200 dollars

The next thing to consider is: why not increase import tariff to curb imports? When you increase the tariff beyond a point, smuggling will become more attractive. Then, imports through official channels will decline and through smuggling will increase.

Can the e-gold scheme be of any use here? Apparently it makes buying gold easier! That means more demand.

Do you know the banking principle? To lend money, banks need to keep only a fraction of it with them. If they have to lend out a 1000 rs they may have to keep only a portion of it, say 200 rs with them.  Since not all the depositors will demand the money at the same time, banks can meet their daily obligations with this minimum amount and lend the rest out. If all the depositors are going to ask for their money one fine morning, all the banks will collapse. But practically this will not happen. With long experience, banks have found out that keeping about 20 percent of the deposit money is enough to meet obligations.

Now, do you understand the connection? Under the e-gold scheme, only a fraction of the gold bought by the people will be kept in physical form. That way demand for imports of gold will be one fifth or so.

Summary: Gold imports - gold imports as a menace - problems caused by gold imports to the economy - multiplier effect - two methods of restricting - quota and tariff - effects of increasing tariff - then into banking principle ...