After years of profit-making, smugglers sneaking in gold from Nepal into India had been rendered jobless by the latter's liberalisation of gold imports in 1997. But now things are looking bright again for the smugglers, thanks to the Bharatiyajanata Party (BJP) government's increasing of import duties on gold by 60 percent. The current 6 to 7 percent price difference between gold prices in Nepal and India now makes gold-running worthwhile all over again.

At least one smuggler in Nepal was ecstatic about the new duty regime. "A Maruti Gypsy can take up to 40 kg. I have 'lines' through Mahendranagar, Nepalganj, Bhairahawa, and even Birgunj. From there we can choose any destination, Delhi, Patna, Calcutta. We are back in business. One trip a month is all one needs." By lines', he means the officials along his chosen route who help him get the consignment to its final destination. Smugglers make an estimated INR 500,000-600,000 (c. USD 13,000) per trip.

India is a bottomless pit for gold, claims the World Gold Council (WGC). It is the largest consumer in the world and irrespective of boom or depression, demand never shows signs of receding. In 1998, India imported close to USD 8 billion worth of gold—a figure that is more than 2.5 percent of its GDP and higher than all its oil imports.

There were two reasons why gold demand was so high last year. First, the shortage of other financial instruments available to channel savings. Equities had been beaten to death, real estate was still on a downward spiral, and interest rates offered on debt instruments were barely above the retail price inflation. Gold, at least, is like buying dollars, and even if the underlying price varies a bit, dollar appreciation of 10-15 percent per year makes up for it. "For those who thought UT1 (Unit Trust of India), the largest Mutual Fund that nearly went bust, was safe, last year was a terrible shock. Now they will touch nothing but real safety," said an investment analyst with a Bombay brokerage. "Indian households are investment savvy, now that Harshad Mehta has taught them their lesson. Gold has everything. Returns, shine, safety, inheritance."

The second reason for India's gluttonous gold consumption was the tax amnesty declared by the Indian government. This was an offer which gave people the opportunity to convert black money into white, in exchange for taxes that were to be levied at a flat rate. However, since the scheme taxed declared cash income at rates far higher than for assets, cash hoarders rushed and bought gold.

Panic stricken at the foreign exchange outflow on gold imports, the BJP government could not have done worse. It hoped (and still does) that the hike in duties will bring in about INR 2.5 billion in revenue, and curtail demand. But that looks unlikely. Dick Ware of the wgc believes that the raising of duty will not really reduce demand, it will only trigger a resumption of smuggling. So the Delhi government stands to lose on both counts: it will neither see declines in foreign exchange outflow, nor increases in tax collections.

After the liberalisation of gold imports in 1997, the black market for gold shrunk by nearly 60 percent. More Indians bought gold from legal channels, which meant that the hawala market (black market for US dollars) also collapsed. No one wanted to buy smuggled gold, so no one wanted hawala dollars and the black market no longer seemed attractive. This meant that the NR1 savings channelled into India started taking the official route—selling NRI dollars through banks rather than the black market, which was not really offering better rates. This boosted foreign exchange reserves and made bank balance sheets healthier. Smuggling gold was simply bad business, and smugglers had to diversify their product line

So when it came to renewing the trade and transit treaty between India and Nepal, the Indian government decided to try and plug the loopholes. Nepali traders are restricted from using random routes to trade with India. Routes, even highways, have to be specified in advance. Nepali importers must furnish bonds and bank guarantees for importing goods that have limited use in Nepal (cellular phones, raw silk yarn, high-tech telecom equipment, etc). And what does the smuggling fraternity on the Indo-Nepal border think of all this? In the words of the smuggler mentioned above: "It's farcical. There are enough loopholes. And why point here? Look at the amount directly getting in from the Middle East. It's even better business there and they are the ones who control the business here.

The Nepali government is all for increasing border control as long as the Indians are willing to shell out the cash. The Indians will not, because, until now, the perceived threat was not here, it was up at Siachen. Now things have changed. Nepal has seen a remarkable increase in the influence of the same mafia that operates so ruthlessly in Bombay (which included the murder of a sitting MP near his Kathmandu home, who himself was said to have deep mafia links). With the bosses in Dubai, this mafia makes money through smuggling and extortion, though not of the scale of its Bombay operations.

The solution lies in making smuggling unprofitable by rationalising duties (for instance, between India and Nepal), which reduces arbitrage and makes the risk not worth the reward. It is also fairly clear that the Indian government must try and root out the mafia dons from Bombay and Dubai, a task which is made tougher by politicians who have a direct stake in extortion and smuggling revenues. Until that happens, more cities will fall under the control of the mafia, which, for the time being, is only getting richer

Meanwhile, given the funding requirements of Nepali political parties in the run-up to the general elections in early May, there is no saying that income from smuggled gold will not make a distorted polity even more so.

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Himal Southasian