Curb gold; raise duties; borrow more – Are these solutions?

The first thing Manmohan Singh needs to do after he dons his second hat as finance minister – however temporarily – is to junk the bad ideas being dusted up in response to the deteriorating external and domestic fronts.

The country’s current account deficit – the gap between earnings from abroad and payments before capital flows – is now at the highest level ever – 4 percent of GDP. The only answer to this problem is to improve export competitiveness – which the rupee’s fall is helping. But the panic responses from ministries and the RBI are not helping.

Consider what the Reserve Bank of India (RBI) did on Monday, in what was billed as a big-bang approach to turning around sentiment: increasing the limit for foreign investment limits in government bonds (up by $5 billion) and allowing companies to borrow more abroad to retire rupee debts ($10 billion).

Both these measures may improve short-term capital flows, but they will result in raising the country’s external debts (read here). Debts have to be serviced – which means more outflows a year or two down the line, when the global situation could be worse (who knows?).

Consider another idea: the Reserve Bank wants to impose curbs on banks selling gold coins to customers. A report in Business Standard quoted an RBI official as saying: “Banks were allowed to sell gold by importing it to fight the excess dollar flows. By the same logic, the measure should be reversed now as we are at the opposite end of the spectrum. It was a temporary measure, which unfortunately was made permanent by banks.”

Temporary measure? Is liberalisation a temporary measure? If policies are created only for short-term exigencies like excess (or sparse) dollar inflows, what is the point is have any kind of stable policy on anything?

In fact, the RBI itself imported 200 tonnes of gold in 2009 to shore up its reserves in a difficult external environment, where holding the bulk of its reserves in dollars would have been risky.

Now, if Indian citizens, worried about the falling purchasing power of the rupee, also decide to stock up on gold, how is it wrong? What is right for the country (importing gold) is not right for the individual? What is sauce for the goose is not sauce for the gander?

Gold import duties have already been raised in the budget. Forcing banks to sell less gold coins will only push the demand towards unofficial channels. The other day, the finance ministry talked about reducing illegal wealth. Here’s the RBI giving the idea a fillip to curb excess gold imports.

The only way to reduce the citizen’s hunger for gold is to bring inflation down so that a rupee remains a rupee in terms of what it can buy. This needs sound money policies, and curtailment of fiscal deficits, among other things.

The third bad idea is to clamp down on all kinds of imports. This is the worst possible idea to manage the current account deficit or the trade deficit, since it will only encourage our trade partners to retaliate on the goods we export.

According to a report in The Times of India, the government will be more aggressive in imposing additional duties on imports where there is some evidence of dumping from the exporting country. China is one obvious candidate for anti-dumping action, and the government has apparently told businessmen that it will complete anti-dumping investigations in nine months instead of the usual 12.

But consider this counter-intuitive point: if someone wants to sell you something below cost, is he doing you a favour or trying to cheat you?

India itself offers many kinds of export subsidies, including interest subsidies, special tax rates and duty exemptions on exports. People in glass houses should not throw stones. Ditto for aggressive action to curb imports.

The point is this: when the rupee has depreciated 25 percent in a year, it’s like imposing a 25 percent tax on imports anyway in rupee terms. What further protection does Indian industry need?

The stupidest idea, of course, is the proposal to levy upto 21 percent additional import duty on power equipment, most of which is coming from China. If we take the rupee depreciation and the 21 percent proposed duty, it will be tantamount to gifting a 40-45 percent special protection to Bhel and Larsen & Toubro, among others.

But assuming the idea is to help these companies fatten up on orders, consider the cost: higher duties means higher power tariffs ultimately. One calculation is that the additional duty will push up power tariffs by upto 50 paise per unit. The whole country will pay for more power to help a few public and private sector companies make better profits in India.

Raising import duties will ultimately raise inflation – which will force the RBI to keep interest rates high and the government to borrow more. And remember, it is the government’s excess borrowing that is generating the high fiscal and current account deficits.

Does it make sense to put forward solutions which will worsen the problem we set out to solve in the first place?

These are the tradeoffs in the solutions being offered:

* Higher tariffs to protect a few companies versus lower power and consumer prices for all

* Direct curbs on gold coins/imports versus indirect encouragement to smuggling and revenue loss.

* Throwing the door open to stable foreign direct investment (in retail, insurance, banks etc) versus raising volatile short-term foreign debt flows to help bolster the rupee.

The answers should be obvious.

(curtsey : first post)

Rupesh Yatesh Dalal
Head Research Department

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