Strategy: You have to be bold when it is gold ::Kotak Sec,

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Strategy
Indian Economy
You have to be bold when it is gold. The Indian Government’s decision to raise
customs and excise duty on precious metals (gold, silver) is a welcome step although it
is quite modest and somewhat belated, in our view. It is unlikely to affect (1) demand
meaningfully for unproductive assets or (2) gold’s use as a store of unaccounted money
in India. We would advocate much higher domestic taxes on gold and precious stones.
Nonetheless, the revision in taxes will partly address two issues—it will (1) increase tax
revenues; we estimate up to `50 bn of additional tax revenues in FY2013E assuming
unchanged demand, prices and (2) likely reduce domestic demand for gold, gold
imports and India’s burgeoning CAD in FY2013E albeit modestly.
Government increases customs and excise duty on precious metals (gold, silver)
Exhibit 1 presents the changes to customs and excise duty on precious metals implemented by the
Government. Customs duty on gold has been changed to a variable rate of 2% of value from a
fixed rate of `300/10 grams and on silver to 6% of value from a fixed rate of `1,500/kg previously.
Similarly, excise duty on gold has been changed to a variable rate of 1.5% of value from a fixed
rate of `200/10 grams and on silver to 4% of value from a fixed rate of `1,000/kg previously. At
current spot prices of gold and silver in India, the changes will cumulatively increase taxes on gold
by `460/10 grams (~1.7% of CMP of `27,428/10 grams) and silver by `2,650/kg (~5.2% of CMP
of `51,500/kg).
A moderately positive step to tackle rising GFD, CAD
(1) Higher taxes on gold and silver can add up to `50 bn to taxation revenues (a portion of imports
is re-exported as jewelry) in FY2013E, assuming prices and demand remain unchanged at current
levels; this will drive GFD/GDP lower, albeit marginally (see Exhibit 2) at 0.05% on our current
FY2013E GFD/GDP of 5.8%. (2) Higher taxes may result in modestly lower domestic demand for
gold (see Exhibit 3) and alleviate India’s high CAD/GDP (3.2% in FY2013E; see Exhibit 4).
The move is quite modest and belated though; damage already done in FY2011, 1HFY12
We would have welcomed higher domestic taxes on gold noting (1) gold’s pernicious impact on
India’s CAD; in FY2011, gold imports at US$35.1 bn alone accounted for ~80% of FY2011 CAD
of US$44.3 bn and imports of gold, silver and precious stones at US$66 bn exceeded India’s CAD;
however, we would clarify that India also exports jewelry and imports of precious metals and
stones less exports of jewelry may be a better figure to look at, and (2) possible use of gold and
precious stones to store unaccounted wealth in India. In our view, India does not have the luxury
of ‘consuming’ such large amounts of essentially unproductive assets (see Exhibit 3 for India’s
consumption) when it hardly produces any gold or precious stones.
Inexplicable surge in exports of engineering goods and surge in imports of precious metals/stones
We wonder if there is a connection between (1) the inexplicable surge in India’s exports of certain
items in FY2011 (see Exhibit 5 and our October 10 and 18 reports Exploring the money trail) and
(2) the sharp increase in imports of gold, silver and precious stones in FY2011. We note that the
imports of gold and precious stones did not translate into higher exports of finished jewelry, which
suggests increased domestic consumption of gold and precious stones. As per official data,
imports of gold, silver and precious stones less exports of jewelry surged to US$36 bn in FY2011
from a mere US$17 bn in FY2010 and US$6 bn in FY2007 (see Exhibits 6 and 7). This figure has
climbed to an astonishing US$31.6 bn in 1HFY12.