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General Awareness topic - How will the falling Gold prices impact the current account deficit?
How will the falling Gold prices impact the current account deficit?
According to a report released by the State Bank of India, the country’s current account deficit (CAD) hit a record high of 6.7 percent in the quarter ending in December 2012. This is the result of the shift in India’s export-import dynamics. India, once a leading exporter of high value goods and products, is now a victim of high volume of imports and low volume of exports. What exactly are Indians importing? They are importing oil and gold.
Compared to last year, the price of gold reached an all-time low in January 2013. This propelled many Indian consumers to purchase gold. The volume of gold that was imported in January 2013 surpassed 100 tonnes, a 23 percent increase as compared to last year. There was a sharp increase in the import of gold in January due to the fear of an increase in import duty on gold in the Union Budget. Sadly, Chidambaram did not increase the import duty of gold in the Union Budget.
According to President Mukherjee, one of the key drivers of the current account deficit is the rise in the import of gold and other precious metals.
India is the largest importer of gold in the world, and experts estimate that oil and gold imports constitute 70 percent of India’s trade deficit. India’s current account deficit stands at Rs 4,076 billion (US$ 75 billion) and the value of gold imports stands at Rs 2,279 billion (US$ 42 billion), which accounts for more than half of the country’s account deficit.
Oil imports have placed immense burden on the country’s current account and with the additional burden placed by the rise in the import of gold, it will be extremely difficult for India to recover from this economic imbroglio.
The current price of gold is Rs 2,876 (US$ 53) per gram, a significant decrease from Rs 3,582 (US$ 66) per gram in 2012. To reduce the import of gold, the government had previously increased the import duty on gold from two percent to six percent.
Sadly, this did not reduce the demand for gold because of domestic inelasticity of demand for gold. Since an increase in the import duty on gold has little or no effect on the demand, the government is left with no choice but to loosen the debt market rules to draw more investments into the country. These investments will in turn finance the current account deficit.
In September 2012, the government came up with a number of liberalization measures to open up more sectors, including insurance, retail and aviation to foreign investors. Some experts say that since the domestic demand for gold is inelastic (with no change in the demand despite higher prices), the government will benefit from an increase in import duty on gold. This way, the government will be able to earn additional revenue to narrow the current account deficit.
Now that the government is aware of the purchasing behavior of Indian consumers, it has to come up with appropriate policies to reduce the current account deficit. Else, the falling gold prices will keep increasing the current account deficit.
This will ultimately reduce the competitiveness of Indian firms in the long run. So, it is time for the Indian government to come up with policies that will attract investors to India. Without money flowing into India, the country’s productivity and economic growth will go for a toss.