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A blog on financial markets and their regulation
The World Gold Council (WGC) reported last week that despite import curbs imposed during 2013, Indian gold demand continued to grow with gold smuggling (what the WGC euphemistically calls unofficial gold imports) compensating for the fall in official imports. This is of course in line with a lot of anecdotal evidence.
In principle, gold smuggling should show up in the balance of payments (BOP) data in some form – after all the smuggled gold also has to be paid for in foreign exchange. For example, smugglers could collect foreign currency from migrant workers outside India and remit the money in Indian rupees to their families in India via the “hawala” channels. Corporate “hawala” could take the form of under/over invoicing of trade or inflating outbound foreign direct investment from India.
The Indian balance of payments data is available only for July-September 2013 while smuggling is likely to have picked up more in the subsequent quarter. Nevertheless, the data does show some tentative evidence for the financing of gold smuggling. For example, in item 18.104.22.168 (Other capital transfers including migrants transfers), the gross inflows fell by nearly $1.0 billion and the net flow fell by $0.8 billion. Similarly, item 3.1.B (Direct Investment by India) rose by $1.2 billion on gross outflow basis and by $0.6 billion on a net outflow basis. I am grateful to my colleague Prof. Ravindra Dholakia for pointing out to me that the gross flows are possibly more important than the net flows.
The WGC data and the BOP data are consistent with the anecdotal evidence that smuggling is on the rise. Some economists tend to be dismissive of such anecdotal evidence – their standard refrain is that “the plural of anecdote is not data”. In finance, we tend to be much more respectful of anecdotal and suggestive evidence. Our standard reflex is to “buy the rumour and sell the fact”. Financial markets are forward looking and by the time conclusive statistical data becomes available, it is too late to be actionable.
In any case, it is dangerous to let smuggling take root. Smuggling of gold requires setting up a complex and sophisticated supply chain including financing, insurance, transportation, warehousing and distribution. Stringent import curbs create incentives to incur the large fixed costs required to set up such a supply chain. But once the supply chain has been set up, it may continue to operate even after the curbs are relaxed so long as the arbitrage differentials exceed the variable costs of the supply chain. In this sense, there are large hysteresis effects (path dependence) in these kinds of phenomena. More dangerously, the supply chain created to smuggle gold can be easily re-purposed for more nefarious activities. In the long run, the gold import curbs may turn out to be a very costly mistake.