Thursday, April 5, 2012

Jewelers' On Going Strike and the Gold Import Duty Question

In the recent Union Budget, Finance Minister Pranab Mukherjee doubled the import duty on Gold as well as imposed a 0.3% excise duty on unbranded Gold products (see here for major issues involved in the on-going strike of jewelers and other Gold market troubles). The reason he cited for this policy move is the unfavorable impact of rising  Gold's import on the trade deficit. The real reason - which the government is hiding from the common man - is the troubles with their own budgetary deficit, which has already breached the limits (this always happens; government hardly runs  a surplus budget). The socialist welfare-warfare state is meddling in every imagined aspects of our lives and that is bound to increase government's all kinds of deficits. To fill the void in their revenue - i.e., loot - they want to mulct the jewelers now.

The problem of trade deficit actually is government's own making. Without government's intervention in the economy, imports will be paid for by the exports and, thus, there will be no question of any trade deficit. What will be bought from abroad will be paid for by foreign earnings. For example, suppose there is one Indian named Raju who is producing goods and services worth 1000 rupees and using that income for consumption of domestic goods. In present the rupee dollar exchange rate is 50:1, and all foreign transactions are taking place through the central banks of respective countries, which is essentially the case presently. Also, the Indian central bank RBI originally has 150 dollars in its Forex reserves. Now, if Raju wants to purchase Gold worth US$50, then, it won't be possible in the present production conditions because he doesn't have any dollars to pay for that Gold import. All his rupee income is for domestic use only. To import Gold he will have to first produce goods or services worth US$50 - i.e., rupee 2500 at the said exchange rate - and sell it (export it) to some American or any other foreign national who is paying him in dollars. The whole process will take place like this. Suppose one American named Marco wants to buy Indian spices. To fulfill his demand, Raju will produce spices worth 50 dollars and sell it (export it) to Marco. Marco will pay Raju 50 dollars check, which Raju will deposit in his RBI account. After this exchange RBI's Forex reserve has gone up to US$200. Now, once having 50 dollars in his account, Raju will purchase Gold from Switzerland making the payment of 50 dollars to Nick in Switzerland by writing a 50 dollar check on his RBI account. RBI will pay 50 dollars to Nick's Swiss central bank where Nick deposited Raju's check. After this transaction, RBI's Forex reserve has come down to its original 150 dollars. As we can see, there is no deficit in RBI's (current) account in this whole trade. Raju's import of Gold is paid for by his export of spices.

The trade deficit can only emerge when Raju is having rupees in his hands which he has not earned by producing and exporting something. And this is only possible in an economy where government and its central bank is printing and creating rupees out of thin air. Suppose RBI prints and loan 2500 rupee to Raju. Raju wants to buy Gold and so he makes a 50 dollar payment through his RBI account to Nick in Switzerland and imports Gold. Now RBI will have to make a 50 dollar payment to Nick's Swiss bank account from his original reserve of 150 dollars! After paying Swiss bank, RBI's Forex reserve has gone down to 100 dollars. Now there is a deficit in the trade account! Not only there is a deficit, this extra demand for dollars and higher supply of rupee will also have an adverse impact on the rupee dollar exchange rate. Dollar will become strong and rupee will become weak! Although my example is highly simplistic to bring the problem in focus, but this is what is exactly happening right now in India.

As we can see above, the deficit would have never emerged if RBI didn't print and loan that extra 2500 rupee out of thin air in the first place. The government is blaming and punishing innocent jewelers for their own shenanigans. They are printing and spending crores of rupees out of thin air, which is eroding the purchasing power of rupee i.e., inflation. To protect their nominal income from this inflation, people are buying more and more Gold converting useless paper rupees in Gold in this process. And this in turn is creating that deficit. On one side inflation is making Indian exports costlier in the international market, which coupled with lethargic western export markets is reducing Forex earnings and on other side people are purchasing Gold imports. This twin factors are creating the deficit. For both these phenomena the government and its central bank RBI is entirely responsible, as usual.  

The only solution of this problem is total removal of government intervention from the Indian economy. RBI should immediately stop creating rupee out of thin air. They should stop all their stimulus packages; stop meddling in the market and stop manipulating the market rate of interest  and money supply. Once there is no free rupee available, no one can buy gold without first earning dollars in the market. If RBI stops eroding purchasing power of rupee by stopping inflation, then, no Indians will rush to buy Gold for protection. After taking this initial steps, we must dismantle RBI and bring India back on the pure 100% reserve Gold standard. In foreign trade, Indians should stop accepting paper dollars for their exports. There is no need to give valuable goods and services to Americans in return of paper dollars which are now becoming worthless because of Federal Reserve's highly inflationary monetary policy. Americans must work hard and produce and export goods and services to pay for their imports. Once the Indian economy is free from the stranglehold of government, it will become stronger attracting more and more foreign investment in India. That will make Indian rupee - which now will be just a name for underlying unit weight of Gold - stronger too. 

Increasing import and excise duties is not going to solve any problems. It will only make the life of people more difficult; it will impose higher opportunity cost and waste resources.  No matter how hard the government will try to stop people from buying Gold, the free market forces will find its own way in the form of thriving so-called black-market in Gold. The underground economy will take over the work of delivering Gold to its customers i.e., the old phenomena of smuggling will come back to life again, and for better.


  1. but why these greedy politicians and govt allow welcome this policy and ready to withdraw their intervention from the market?

    1. I am sorry but I don't understand your question Gaurav? They will not withdraw because they don't want to give-up their political power.


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