The Indian government has raised the import tax on gold by 2 percentage points to 6 per cent to curb purchases and rein in a ballooning fiscal deficit, but industry officials expect only a moderate drop in demand.
India's passion for gold, seen by many as a hedge against persistently high inflation, has led to a rise in its current account deficit, which reached an all-time high of 5.4 per cent of gross domestic product in the July-September quarter.
Alarmed by the mounting current account deficit, driven by large-scale gold imports, the government raised the import duty on gold and platinum to 6 per cent from 4 per cent.
"It is difficult to establish the impact (of the tax) on CAD (current account deficit) and by how much it will come down, but there will be some moderation in gold demand," Economic Affairs Secretary Arvind Mayaram, told reporters.
The tax would be reviewed if imports moderate, Mr. Mayaram said.
The widening current account deficit has increased India's need for foreign capital inflows and evoked memories of the 1991 balance of payments crisis, when the Reserve Bank of India (RBI) sent 47 tonnes of gold to Europe as collateral for a loan to avert a sovereign default.
India has been struggling with a trade deficit that has put the country's current account balance under pressure. To revive exports, the government last month extended an interest subsidy scheme for some exporters.
The duty hike and government's appeal to consumers to cut purchases might not help, largely due to the penchant for gold in India, the world's biggest importer.
India vies with China as top global consumer of gold, and with nearly all demand covered by imports, the country's purchases are a major factor in global prices.
Demand has declined only modestly so far following a 13-per-cent rise in domestic gold prices last year and some higher taxes.
As the government started talking about curbing imports, industry players said the sheer charm of gold and demand buoyed by heady inflation and meagre savings would blunt the impact of any rise in duties.
"The government's revenue will increase, but imports won't diminish," said Mohit Kamboj, president of the Bombay Bullion Association.
Fundamental reasons for buying gold – to hedge against inflation and currency risks – remain as strong as ever, said Amresh Acharya, director of investments at the World Gold council, a trade body funded by miners.
But a jewellery association, which had lobbied against any increase in the import duty, said imports could fall 25 per cent.
Industry analysts fear the increase in the import tax could spur smuggling across porous borders. Illegal trade was rampant before restrictions on gold shipments were lifted in 1990.
"There has been a lot more talk this time around that this will stimulate more smuggling," said David Jollie, analyst at Mitsui Precious Metals in London.
The global market had factored in the increase in the duty, said Afshin Nabavi, senior vice-president at MKS Finance in Geneva.
Finance Minister P. Chidambaram had hinted at an increase in tax on Jan. 2, triggering a massive jump in imports, which traders estimate at about 40-50 tonnes in the first week of the month. Premiums charged on London prices rose to the highest level in two months to $2-3 (U.S.) an ounce.