Gold smugglers - Bollywood's favourite screen villians of the 80s - are back with a bang. 

As India's embattled federal government fights to clamp down on gold imports with a view to bringing down the current account deficit, smuggling of the precious yellow metal into the country has witnessed a quantum jump.

On the face of it, the government measures to tighten gold imports are working: In September quarter of this year, gold imports into India fell 63 percent over the previous year, or to 85 tonnes. 

The measures included calibrated hikes in import duties to as high as 10 per cent to stifle gold and jewellery consumption. 

But, unfazed by the measures, India's population continues to chase gold and jewellery across the length and breadth of the country. The duty hikes have only led to the return of gold smugglers.

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Gold seizures are up nearly 400 per cent this year. In the two months of September and October customs officials seized around a tonne of gold from air travellers. But air is just one of the routes. The Indian demand for gold through unofficial channels have in turn resulted in rising imports by neighbouring countries especially, Sri Lanka, Bangladesh and Nepal. In fact, some of the land seizures of gold were from couriers from these countries.

World Gold Council (WGC) Managing Director (India) P R Somasundaram said: "Gold imports were only 85 tonnes in the third quarter against the demand of 148.2 tonnes for the same period last year ... If this supply restrictions continue the demand in the fourth quarter will be met through unofficial channel which has grown significantly."

Loss in tax revenues

Customs officials admit that the seizures were barely 10 per cent of the quantity smuggled into the country. In fact, since the hike in duties this year, smuggling from both air, sea and other channels is up by about 40 to 50 tonnes according to Business Standard newspaper.

Given the scale of smuggling it is doubtful whether duty hikes resulted in increased revenues to the government. On the contrary, it most likely led to a loss in tax revenues.

Gold seizures have increased 400 percent this year [EPA]

The surge in smuggling is partly as a result of the price differentials. Domestic prices are presently about $40.50 per gramme (Rs 2550) higher by at least 60 US cents per gram. If the high duties are included then the domestic price is about $44.50 (at present exchange rate of Rs 63 per U S dollar).

The reason for the high price differential stemmed from Indian demand for the yellow metal. India's demand during the September quarter alone was about 148.2 tonnes. A large part of the gold is however savings driven.

At least 72 per cent of India's household savings amounting to about $39 billion are in the form of gold and real estate. The impulse to save in gold has increased during the last few months, due to high consumer price inflation.

Consumer price inflation is presently raging at about 13 per cent. Bank deposits offer barely nine per cent interest. That would mean savers are poorer by at least four per cent each year. Gold prices on the other hand have increased by at least 20 per cent per year since the beginning of the millennium. That made gold an automatic inflation hedge.

All classes save in gold

But it is not the upper middle classes alone that save in gold. Savers in gold come from all classes, communities and religions. Gold savings were mostly in the form of small coinage and jewellery.

The preferred coinages range from quarter sovereign (2 gram) of 22 carat purity to one sovereign (8 grams). Farm hands, rural labour and industrial workers all park a portion of their incomes in gold.

Savings in gold though is not a recent phenomenon. Traditionally such savings were parked in temples, churches and even Kerala's mosques. The clergy of these religious institutions functioned as custodians of the savings that were utilized during period of drought or natural calamities.

Gold stocks as a result of these cumulative savings are estimated to be huge. Thomas John Muthoot of Muthoot FinCorp, a large lender to farmers and rural communities against mortgage of gold, estimates," Gold stocks both in the official vaults and with households will be at least 50,000 tonnes."

India's obsession with gold jewellery has a long history [AP]

The WGC's figures are lower at 40,000 tonnes. Even so the holdings are large, or at least five times more than the stocks with the United States Federal Reserve and far higher than India's official holdings of 557.75 tonnes, according to the Reserve Bank of India Annual Report 2012-13.

Banks and non-bank finance companies have taken advantage of the Indian appetite for gold by importing and converting them into branded coins. It has also prompted smaller coinages of as low as one gram by the NBFCs.

The savings in gold are also utilized by farmers and rural communities to raise cheap credit for meeting their working capital needs. Most rural communities in India are presently outside India's organized credit markets, or banking institutions.

State owned banks impose hurdles to small rural borrowers and private sector banks discourage them. Even if credit is available, the interest rates are high. Instead it is the non-bank finance companies (NBFC) that meet the instant liquidity needs of rural communities against gold.

Even these institutions are under regulatory surveillance. Lending against gold is being controlled since July this year. Non-bank lending institutions are no longer entitled for refinance support from banks for gold mortgaged loans.

Moreover, NBFCs are permitted to lend only up to 60 per cent of the value of the gold. Yet despite the tight regulations, more institutions have mushroomed to provide gold mortgage small ticket loans to rural and farm communities. In fact even large financial institutions like HDFC have entered the fray to provide credit against gold as collateral.

Regulations to protect banks

The tight regulations though are partly to protect the banking and financial sectors. Banks and the rest of the financial sector have been severely dented by the migration of savings into gold.

The result is that bank's interest costs on deposits have increased. Savers have moved away from the equity markets. Only about 2.5 to 3 per cent of household savings go into equities and mutual funds. Consequently organised sectors' cost of credit has also increased. Borrowing costs are as high as 13 per cent.

Organised industry has in turn turned to external commercial borrowings as a source of credit for meeting investment requirements. But the repayment cycles of the cross border corporate debt have increased the rupee's vulnerability and further complicated the government's battle against inflation.

Since January this year, the Indian rupee has dipped by 16 per cent against the dollar. Currency depreciation has translated into rising import costs for industry and high energy prices. India imports almost 80 per cent of its oil and gas needs.

Worse, with foreign non-debt capital flows and export earnings remaining weak, options for raising domestic liquidity is limited without further fuelling inflation. This is because rupee liquidity can be released only if there is increase in dollar flows. The RBI purchases the dollars and releases rupees in to the domestic banking system.

The predicament in turn has mounted pressure on a beleagured government to dive into the "Gods gold horde." If the divine gold comes into the RBI vaults, it would mean that money supply could be increased.

There is an immediate problem though. The gods at the moment don't need cash from the government, banks or the RBI! That leaves only a final option – Borrow the gold from the gods by issuing IOUs (issue of gold bonds) to bail out a flagging economy. Confiscation is a politically unpalatable solution.

Source: Al Jazeera