The nine percentage point cut in the import duty on gold is acute. “This is the sharpest reduction on record and the lowest since June 2013,” observes Kavita Chacko, Research Head, India, World Gold Council. Though the reduction in duty caused the price of gold to crash, and gold bond and ETF prices also declined, many other gold bonds saw a marginal 1-3% drop. The impact on SGB issuances varied as per the time left for bond maturity, trading volumes as well as premium that the bond was trading at before the Budget. Mrin Agarwal, Founder Director, Finsafe India, insists, “The impact of the duty cut on the value of gold has been overstated.”
This cut in import duty must not be seen in isolation. It is the first after a sustained rise in import duty on gold over a period spanning 12 years. The import duty had steadily risen from 2% in January 2012 to touch 15% in July 2022, with only one cut in the intervening period. Clearly, duty hikes in gold have been far more frequent than cuts. After every hike, the domestic value of gold and, by extension, the traded value of gold ETFs and SGBs have also increased. So, even as gold investors have suffered a loss after the recent cut, they have also gained from duty hikes in the past. In fact, when the first SGB was introduced in November 2015, the import duty on gold was 10%, observes a note by Primeinvestor.in. This was hiked to 12.8% in July 2019, slashed to 10.75% in February 2021, and hiked again to 15% in July 2022. The two hikes lifted domestic gold prices and helped investors fetch higher value for their SGBs and gold ETFs. Two tranches of SGBs have also been redeemed at those higher prices when the 15% import duty was in force, the Primeinvestor note mentions.
9% import duty rollback is the steepest ever
To be sure, changes in import duty on gold are not random. These are part of the government’s policy framework to manage the country’s current account deficit or any vulnerability in the rupee. Among other things, the recent cut was done to arrest the rising smuggling of gold into India. The previous duty hikes had made it expensive to buy the yellow metal via the front door, making the illegal trade more attractive.
“The customs duty reduction will make gold imports via unofficial channels less (or even non-) profitable,” Chacko asserts. The duty cut was also meant to give a fillip to India’s exports of gems and jewellery, which has seen a slowdown owing to weak global demand. Chirag Mehta, CIO, Quantum AMC, remarks, “India is a price taker in gold. The prevailing elevated duty structure— widening the differential between global and domestic gold prices—was distorting the market significantly.” The duties were raised previously to rein in gold imports at a time when India’s trade deficit was bloated. It is not as acute now.
For investors who were looking to exit their holdings to meet expenses, this is a sizeable drop. SGB investors feel particularly targeted by this cut. There is a belief that the government cut the import duty deliberately with a view to reducing its payout to investors of SGBs maturing in the coming months. This is a misreading. The cut impacts investors in all gold instruments equally, not just SGBs, remarks Agarwal. Besides, the savings the government will make on its outgo on SGB redemptions will be negligible, observes Primeinvestor.
Investors fear that duty changes in the future will continue to wreak havoc on gold investments. On the contrary, investors who hold for longer may even recover some of the losses. “If you hang on to your SGBs till maturity, the loss from the customs duty cut can be made up by other factors that spike global gold prices or weaken the rupee,” argues the Primeinvestor note. Already, the precious metal has recovered some of its lost value. The reality is, customs duty is only a minor factor deciding local gold prices. “There are other variables, such as international gold prices, demand-supply of gold and rupee-dollar exchange rate that overshadow customs duty as movers of gold prices,” Agarwal points out. International gold prices, in turn, are driven by variables such as strength in the dollar, geopolitical tensions, inflation and central bank purchases, among other things.
Experts maintain that gold continues to offer a compelling investment proposition, irrespective of any duty changes. Mehta asserts, “Gold retains its defining characteristics as a portfolio diversifier, store of value and source of liquidity. It will continue to offer stability when other risk assets decline.”