Home / Opinion / Gold imports = capital flight from households?

When I began researching why we count gold on the current account and not the capital account, I was simply seeking an answer to what looked like an illogical classification of a metal we know to be an asset. And as it is with most things, once you start pulling at a thread, sometimes you get surprised at what sits at the other end. So here is what I finally find. The question (asked in my previous column http://bit.ly/1a2YHp8) is this: why do we count gold imports in our current account and not the capital account? The question has been triggered by the flak households are getting for causing India’s current account deficit to get out of control due to their lust for the yellow metal. The first answer seems to be convention—we use international standards to place items in one account or the other. The logic of placing gold in the current account is that transactions in goods, even those that may have investment value, are included in merchandise trade. And that since gold does not go to work but sits in lockers and vaults – it does not qualify as an asset. Therefore, the metal’s classification as a traded “good" and not an “asset". And, therefore, its placement in the current account.

But there is a contradiction here between how we treat gold in our international trade account and how we treat it domestically. We tax gold as an asset in India where even personal gold jewellery is treated as an asset under section 2(14) of the Income-tax Act. Short-term capital gains (if held for less than three years) are taxed at the marginal income tax rate of individuals and long-term profits (held over three years) are taxed at 20% with indexation. Physical gold has to be declared when the wealth of a person is calculated to levy wealth tax. Gold exchange-traded funds (ETFs) are treated as assets as well, though they become long term as soon as they complete a year of investment. So may be we need to think this through as a country. Is gold an asset or is it not? Or is it an asset when it suits us and not when it does not.

Another argument thread says that it does not matter where we count gold—current or capital account—but the net effect is a flight of dollars to import the metal. Right, but if we count it correctly—that is on the capital account as an asset should be—the story moves from silly households buying shiny metal to that of capital flight from households. And that changes the dimension of the problem, and therefore maybe the solution. R. Jagannathan, editor in chief, web and publishing, Netowrk18 argued in a Firstpost.com column earlier this year that buying gold for the household is like opening a tiny Swiss bank account (you can read the post here: http://bit.ly/19eSy7K). His argument is that the rich have avenues to hedge their currency and political risk (industry takes its investment abroad, high net worth individuals buy assets abroad), but the households do not have the capacity or the money to do that. Their defence against a falling rupee, inflation and very grim political uncertainty is to move their money abroad by importing the one thing they understand that the world also understands as a store of value—gold.

A third thread of conversation arising from the previous column wondered what retail portfolios should look like, given that gold is an asset—should we all just buy gold? As retail investors we need to understand that buying gold is the easiest way to hedge our portfolios against rupee depreciation, inflation and to introduce global diversification—but this should not be more than 5-10% of the overall portfolio. Equities remain the best inflation hedge over the long term—though the current point to point return numbers look dismal. But remember, equity is a long-term investment and is linked to the growth of the country. And, that democracies have a way of going to the brink, having a gun to the political head before tough decisions are taken. We’re at that point. So, stay with keeping about half the assets in equities. The rest stays in long-term, tax-friendly products that are zero risk. Anything more than that needs a financial planner who works for you and not for his commission. These are tough to find—so stay with the basics and stay safe.

End note: Ever wondered why is gold gold? What gives it its place in the world that goes back to the beginning of known history? I found this fascinating story on NPR, a US based not-for-profit media organization, that finds out why it is gold and no other substance that has been the store of value across time. Sanat Kumar, a chemical engineer at Columbia University, crosses out substances from the periodic tables because they are not solid, or corrode, are radioactive, or too common or too rare and zeroes in on four metals that have the qualities that a pre-paper physical store of value must have. Gold emerges as the best of the four for reasons you can read about here: http://n.pr/17V0rRT.

Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, and Yale World Fellow 2011. She can be reached at expenseaccount@livemint.com

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