The RBI’s tiny pot of gold
thehindubusinessline.com
India’s gold reserves are just 3.5 per cent of its foreign exchange reserves. The instability of major reserve currencies has cost the country dear and a more active official gold reserves policy would have paid rich dividends, says S. S. TARAPORE.
India has all along been the largest market in the world for gold. Yet, for many years, policymakers have denigrated the proclivity of the masses to buy and hoard gold. Paradoxically, all decision-takers, in their individual capacity are addicted to gold which, in a sense, is Nature’s gift.
For many years, central banks treated gold as a barbaric relic which was unproductive and, therefore, to be discarded from the foreign exchange reserves. Central bank-speak and central bank action in many countries were ambivalent.
In 1965, General Charles De Gaulle, the then French President, on the advice of the percipient economist, Jacques Rueff, called for a return to the gold standard. While it was Gen De Gaulle who thundered on the return to gold, it was Germany that quietly built up the gold portion of its reserves.
OFFICIAL SILENCE
For all the talk about moving away from gold in the official forex reserves, the major industrial countries — the US, Germany, France, Italy, Netherlands, Portugal, Spain, Austria and Belgium — continue to hold a large proportion of their reserves in gold.
Developing countries generally hold only a small proportion of their reserves in gold. In recent years, a number of countries have been building up their gold reserves, including Russia, Japan, China, Venezuela, Mexico, Brazil and the Arab countries.
India’s gold reserves were built up largely through the transfer of confiscated gold by the government to the Reserve Bank of India (RBI).
With the liberalisation of the gold policy in 1991, the supply of confiscated gold dried up and the RBI’s gold reserves have been stagnant for a number of years, at 357.7 tonnes.
The mainstream view in India was that any buying or selling of gold by the RBI was dangerous; hence, even discussion of the issue was taboo. The views of Governor S. Venkitaramanan and Governor Y. V. Reddy stood out as exceptions, but they were unsuccessful in bringing about a change in the inactive policy on official gold reserves.
Contrast this with the explicit policies of the Chinese and Russian central banks on building up official gold reserves.
POLICY ON GOLD RESERVES
The totally passive official gold policy has not really been beneficial. When the RBI’s forex reserves fell to a critical low level in 1991, the gold proportion of the reserves was very high. Since then, the forex reserves have risen massively and the gold proportion fell to 3.5 per cent of the total. In retrospect, the instability of the major reserve currencies has cost India dear and a more active official gold reserves policy would have paid rich dividends.
Other than accepting the restitution of gold to member-countries by the IMF in 1976 as also purchase through IMF auctions exclusively for member-countries at a uniform price, the RBI has not undertaken any steps to augment its gold reserves.
In this context, the purchase of 200 tonnes of gold from the IMF during October 19-30, 2009 at the prevailing international price is a move which will go down in history as a watershed in the RBI’s official gold policy. The RBI Governor, Dr D. Subbarao’s bold measure deserves rich accolades.
It is true that the RBI’s purchase of gold at a price well over $1,000 per fine ounce could be considered risky in view of the volatility of gold prices. But the central bank would obviously be maintaining its additional gold holdings for the long haul.
While it is difficult to predict the future course of the gold price, it is well known that demand for gold is far outstripping supply. Market forecasts are that over a three- to five-year period, gold will touch $2,000 per fine ounce.
Ideally, the purchase of 200 tonnes of gold by the RBI should have been undertaken in small lots, spread over an extended period of time. But, given the powerful anti-gold policy-making lobby, the one-shot purchase of 200 tonnes is a practical second-best policy option. What should the future course of RBI’s gold reserves policy be? In keeping with the practice of recent years of open and transparent debate, there is a need for a discussion paper on the contours of an official gold policy. After a detailed debate, the RBI should take its own decisions.
ISSUES FOR DEBATE
The issues which need to be discussed are, inter alia: first, what should be the proportion of gold in the RBI’s forex reserves? Second, should any purchases be exclusively off-market bulk purchases from the IMF or should there be market purchases in small lots?
Third, should RBI manage its gold reserve by purchases as well as sales as it does for other currencies? Fourth, should there be location swaps?
Fifth, should the quality of RBI’s gold reserves be evaluated against London Good Delivery Standards and a rigorous audit undertaken especially to ensure that RBI has totally converted its trinkets into standard bars.
Sixth, should RBI undertake gold dollar swaps with forward cover, lease gold and actively place gold deposits not only with central banks but internationally established banks dealing with gold? And seventh, should the RBI’s return on gold be evaluated against international benchmarks?
To kick off the debate, a few thoughts are set out:
First, RBI should endeavour to build up its gold proportion of the reserves to say 15-20 per cent of total forex reserves; this is vital as gold and the US dollar move inversely.
Second, in future, the RBI should undertake purchases in small lots; if this does not pass the powerful official anti-gold lobby, the RBI should pursue further bulk purchases from the IMF.
Third, there must be a policy framework for small sales as there is for other foreign currencies.
Fourth, locational swaps should be considered to upgrade the RBI’s gold holdings to internationally accepted quality standards.
Fifth, there should be a rigorous dedicated audit of the RBI’s gold holdings.
Sixth, any legislative constraints on active gold trading on the RBI should be quickly removed. And,
Seventh, the RBI should publish the overall return on the active gold portfolio as it does for its foreign currency reserves.
There are also other gems in the dark unfathomed caves of the RBI. One can understand if the RBI top management is unaware of certain transactions before it came into existence . During World War II, the US provided Lend-Lease of silver, which was used in coins; as such the RBI has a small silver nest egg. While it is prudent to have such nest-eggs, they should be usable in a crisis. Even if the silver nest-egg is small, a silver-gold swap could be considered.
The RBI had undertaken such a tiny swap in 1992. This could be combined with a locational swap. The recent official gold transaction of the RBI could be a turning point and the RBI should use this opportunity to get rid of the tyranny of the status quo on official gold reserves.
(The author is an economist. blfeedback@thehindu.co.in) |
