All that glitter: More gold in RBI reserves adds to stability, but the central bank must hedge against depreciation – The Financial Express

Clipped from: https://www.financialexpress.com/opinion/all-that-glitter-more-gold-in-rbi-reserves-adds-to-stability-but-the-central-bank-must-hedge-against-depreciation/2367312/

The RBI report has flagged options for active management of gold including making deposits and gold swaps with bullion banks, and exchange traded funds.

The question naturally is when gold no longer plays a direct role in the international monetary system, why are central banks like RBI holding extensive gold reserves, amounting to 17% of worldwide stocks.The question naturally is when gold no longer plays a direct role in the international monetary system, why are central banks like RBI holding extensive gold reserves, amounting to 17% of worldwide stocks.

Like other central banks in emerging economies, RBI has been steadily adding gold to its reserves. RBI’s gold-holding has gone up by 125.6 tonnes in the last two years, making India the world’s ninth-largest holder of gold reserves. As of September, the central bank held 743.84 tonnes of gold, 11% more than the 668.25 tonnes in September 2020, according to the The Indian Express. The share of gold in the total forex reserves has accordingly increased to 5.88% in end-September. The question naturally is when gold no longer plays a direct role in the international monetary system, why are central banks like RBI holding extensive gold reserves, amounting to 17% of worldwide stocks.

As is the case with individuals, central banks hold gold as a hedge against uncertain times to protect against economic instability. When India faced a serious balance of payments crisis in 1991, for instance, the country had to pledge 67 tonnes of gold to the Union Bank of Switzerland and Bank of England to bolster its dwindling forex kitty. Today, with $642 billion of forex reserves, the external vulnerability of 30 years ago may have receded substantially, but there are always fresh risks on the horizon. Around 67% of RBI’s foreign currency assets are invested in securities, including US treasuries. So, buying more gold helps the central bank to diversify its portfolio of reserves.

During the last couple of years, however, the allure of gold was compelling for RBI due to the challenges of forex reserve management when yields on securities are low. The weakening of the dollar, thanks to the stimulus rolled by the US Federal Reserve and near zero interest rates prompted RBI to diversify its forex reserves away from dollar-denominated assets. Interest rates in advanced countries have been on a declining trend over the last four decades and reached their historic low in many of them in 2020, according to RBI’s report titled The Low Yield Environment and Forex Reserves Management. Gold has an inverse relationship with the US dollar: when the latter dips in value, gold rises, enabling central banks to shore up their reserves.

But, there are limits to accumulating gold, especially if it is fast losing value. For instance, the value of RBI’s gold holdings rose by just $960 million, to $37.4 billion, in September from $36.4 billion a year ago. The valuation declined as gold prices first soared to Rs 56,000 per 10 grams last year and later fell below the Rs 48,000-mark. Will the central bank then sell some of its gold holdings? The problem is the emotions among most people of this country over gold sales.

The 1991 move to pledge gold thus occasioned tremendous national angst. In sharp contrast, the move to buy 200 tonnes of gold from the IMF in 2009 was cheered. The RBI report has flagged options for active management of gold including making deposits and gold swaps with bullion banks, and exchange traded funds. If the central bank’s gold holding is a depreciating asset, will it consider investing part of its rising forex reserves in equity funds, especially index funds, to secure better returns in a structural low-yield environment?mail logo

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