Amidst the gloom driven by slowing growth and rising inflation, one indicator that has pleased the government is the sharp decline in the current account deficit on India’s balance of payments. In a surprise development, India’s current account deficit fell sharply to $5.2 billion or 1.2 per cent of GDP during July to September 2013 (Chart 1). In previous quarters, high gold and petroleum imports (Chart 2) had taken the deficit to levels at or above 5 per cent of GDP. During April-June 2013, for example, the deficit stood at $21.8 billion or 4.9 per cent of GDP making capital flows crucial to finance the balance of payments. In most recent quarters gold and petroleum product imports together accounted for close to 50 per cent of India’s total imports (Chart 3).

While the decline in the deficit is welcome for a country that only recently experienced a sharp depreciation of its currency and which is faced with the prospect of declining capital inflows as a result of the tapering of the US Federal Reserve’s bond-buying policy, it may be too early to take comfort. This is because almost all of the decline in the deficit is on account of a fall in gold imports from its level of $16-18 billion during the three preceding quarters, to just $3.9 billion during the third quarter (July-September) of 2013.

The government would of course claim that the fall in gold imports is on account of its policies, which involved a step-wise increase in the import tariff on imports of gold. The duty, which was set at 2 per cent on January 17 2012, was raised to 4 per cent in the budget or 2012-13, to 6 per cent on January 21, 2013, 8 per cent on June 5 and 10 per cent on August 12, 2013. What is striking, however, is that gold imports remained high till May 2013. Further, estimates based on World Gold Council statistics place India’s gold imports in 2013 at 902 tonnes as compared with a lower 860 tonnes in 2012. Duty increases seem to have had effect only with a substantial lag, if at all.

One explanation for the persistence of high imports well after tariffs began to be hiked could be that realising that current account pressures would force the government to act to curb gold imports, dealers and the jewellery industry imported and hoarded excess quantities of the yellow metal. The fact that the government chose not to impose quantitative restrictions but, instead, stuck to raising import duties and imposing a re-export obligation of 20 per cent on importers, facilitated this move. If this was the actual consequence of the government’s policy stretched-out duty hike, it is to be expected that once a large hoard has been built up importers would hold back on further imports till stocks are partly cleared. The net result would be a collapse of imports of the kind seen recently. As compared to an average monthly import of 72 tonnes of gold in 2012, and imports of 142 and 161 tonnes respectively in April and May this year, imports in August stood at 3.38 tonnes and that in September at 7.24 tonnes.

The fall in imports is being attributed to the confusion caused by the re-export requirement, and not just the duty hike. But the truth could be otherwise. Further, besides pre-emptive imports to beat the import policy, two other factors could be encouraging the downward trend in imports. One is the expectation that gold prices that have plunged this year after many years of increases, would continue to decline. If the stock position of dealers is good, it may be better to wait for further price falls. Second, expectations are that the government would reverse its tariff duty hikes once inflation indexed bonds catch on as an inflation hedge. Even the central bank governor has declared that smuggling is bound to rise with duties as high as they are and Commerce Minister Anand Sharma has promised a review of gold import norms at an “appropriate time”. If duties are likely to fall, imports are best delayed.

If all this proves true, the recent collapse in imports may be just a short-term episode and we could see a return to the high import levels witnessed last year. That would take the current account deficit back to unsustainable levels. What seems absolutely essential is for the government to maintain curbs on official imports of gold, track down and penalise smugglers to limit the practice and also seek out ways of reducing oil and non-gold, non-oil imports. Only then would the vulnerability that characterises India’s balance of payments position be truly resolved and sustainability ensured.