Gilt trip: High taxation on gold is meant to curb imports, but all it does is boost smuggling

In early July, customs officials at the Thiruvananthapuram international airport intercepted a diplomatic consignment from UAE containing 30 kg of gold valued at about Rs 15 crore. While the yellow metal is smuggled into the country fairly regularly, the use of diplomatic baggage set off alarm bells in various agencies, including at the National Investigative Agency (NIA), the country’s top counterterrorism organisation.
Two former employees of the UAE consulate were arrested and further investigation has pulled into its orbit senior government officials, a news anchor and politicians, triggering conspiracy theories, innuendos, daily disclosures and suspicions of terrorist links. Ahead of the local body elections planned for October and state assembly polls next year, the smuggling case has painted the Communist Party of India (Marxist) government headed by Chief Minister Pinarayi Vijayan into a corner.

Kerala has had an eternal love affair with gold. Legend has it that in the 15th century when Portuguese explorer Vasco da Gama arrived in Kozhikode bearing presents of fine cloth, beads and trinkets for the king, he was ridiculed and then unambiguously told that the only acceptable gift in the zamorin’s court was gold. Predominantly consumed as jewellery, gold is a customary bridal gift. Some unofficial estimates suggest that Kerala consumed 60 tonnes of the yellow metal in 2019. That is about 10% of the national consumption.

PR Somasundaram, managing director of World Gold Council (WGC), the most authoritative industry body, says there is no statewise estimate, but South India accounts for 40% of India’s total gold consumption. An NSSO household consumption survey in 2011-12 had found that rural Kerala spent on average Rs 208 per capita per month on gold jewellery. The next was rural Goa which spent Rs 34 per person per month. This voracious appetite impacts India’s foreign trade balance as the metal is the second biggest chunk in India’s imports by value. When the balance becomes too unfavourable, governments look for ways to curb imports by raising duties. However, all it does is boost smuggling.
“High customs duty and tax is the only reason for the rise in gold smuggling,” says Somasundaram. Demand growth for gold is directly tied to income levels. Gold demand jumps 1% every time the national per capita income level rises 1%. “Over the past five years, gold demand has slumped by about a third,” says Somasundaram. That is a clear indication of the pressure on incomes.

There is no data on how much gold is smuggled into Kerala. Customs officials say they manage to catch only 10-15% of what flows in.

Much of the gold business had become above board and smuggling had thinned to a trickle after India began liberalising its economy in 1991 and gradually lowered customs tariffs. As India’s current account deficit started widening in 2012, the then finance minister P Chidambaram hit gold with high duties. Within a year, the quantity of smuggled gold jumped nearly 20 times, per WGC estimates. In 2019, newly sworn in finance minister Nirmala Sitaraman hiked it by another 2.5 percentage points. Adding a 3% GST, the effective tax on gold in the customer’s hands became 15.5%.
Multiple sources in the gold business and customs department acknowledge it as the favourite currency of the black market. Money seamlessly flows back and forth from gold to real estate to dollars. “Gold smuggling and hawala go hand in hand,” says a senior banker. Because of its high weight to value ratio, it is relatively easy to keep the entire value chain out of the formal system.

“There is always an element of money laundering in it,” a senior customs department official told ET Magazine on condition of anonymity. “Much of the gold smuggled into the state is used for jewellery, political financing, converting black money into white and hoarding,” he says.

He adds there are multiple hawala syndicates operating between Gulf countries, mainly the UAE, and Kerala. They ask agents in those countries to crowdfund purchases of gold for distribution in the state. The metal is brought in through five major channels — sea, land, air cargo, passengers and privileged cargo. The preferred route, however, is air passengers who act as “mules”. In 2019-20, the Kochi Commissionerate of Customs seized 540 kg of gold, more than double the 251 kg of the previous year. It also registered over 800 cases of smuggling in the state that year.

The customs official says they held a meeting of banks and government-owned trader, MMTC, last year and urged them to aggressively sell gold in the market to raise supply. However, they were unable to help because private sellers undercut them by a wide margin. A senior official at a large Kerala-based jewellery chain told ET Magazine that as gold price rises, a lot of old metal stashed away by households reaches the market either to be exchanged or encashed. This year, the Covid-19 pandemic has forced many households and businesspeople to liquidate their gold holdings to raise money, he says.

A senior MMTC official in Kerala says the company’s Kochi office used to import about 2,000-2,500 kg of gold bullion six years ago. “I used to get calls as late as 11 pm from jewellers who would be watching the New York rates,” he recalls. With customs duty at rock bottom, MMTC could stock gold in vaults and respond to demand quickly. “Anyone could walk in, provide KYC (know your customer) and buy gold,” he says. That became a risky strategy because duty is calculated on the import value and international prices move fast.

It also hits MMTC on service tax which is levied per transaction and since it imports as per orders, ends up paying a sizeable amount in tax. Big private importers in contrast are able to consolidate orders and keep stocks in vaults, making their rates competitive.
MMTC Kochi now imports about 150-200 kg annually to supply primarily to exporters. Buyers pay customs duty and GST in advance to MMTC and get 90 days’ time to export the finished goods upon which the security is returned. The official says many of these units now prefer to receive gold at airports outside Kerala because the customs department at Kochi airport doesn’t accept purity certificate from assayers and checks purity themselves. That delays consignments by another month or so, he says.

Mohan K, vice-president and country head, agri, micro and rural banking at Federal Bank, says the RBI banned retail sales of gold (by banks) in 2013. Although it allowed sales of the Indian Gold Coin launched by the government in 2015, banks hardly sell it. Mohan, who started gold retailing and metal loans at the bank, says buyers carry the risk of price movement, exchange rate fluctuation and about 3.5% interest rate charged by the bank.

The senior official at the jewellery chain says they would prefer to buy from banks or MMTC but often big private importers offer them better rates and deliver quickly.