Why The RBI Should Behave Like a True Indian & Buy More Gold For Its Coffers

In November 2009, the Indian government took one of its wisest decisions: it bought 200 tonnes of gold from the International Monetary Fund (IMF) to shore up its foreign exchange reserves. This gold has given it the best returns on investment, despite the weakness in gold prices over the last couple of years. Those 200 tonnes, bought for around $6.9 billion, are worth nearly $8 billion at current gold prices.

Mint newspaper recently raised a question on whether India should buy more gold, and came up with an inconclusive answer. My answer would be a clear yes. India needs to hold somewhere around 10 percent of its reserves in gold, and it is currently just about 5.5 percent of the total. The time to shore up on gold is when its prices are reasonable, not when the metal is on fire.

Several reasons why.

One, the world is still overloaded on the dollar, and there is no saying when that currency will decline to reflect its true value. Currently, nearly 64 percent of the world’s official foreign exchange reserves are in US dollar, when the US economy’s share of world GDP is just over 23 percent. This lop-sidedness is because the US dollar is considered the only safe haven, at a time when the euro is going through its own turmoil. For a country that has run a current account deficit for as long as one can remember, the strength of the US dollar is largely the result of the TINA factor – there is no alternative to the dollar. The dollar’s current value is not its real value. One cannot predict when it will fall, but it surely will. It cannot defy the laws of economics forever.

Two, India’s over-reliance on holding foreign currency assets (FCAs) in dollar-denominated assets is a clear loser. In 2014-15, the Reserve Bank’s FCAs earned a princely return of just 1.36 percent when the country is borrowing FCAs at more than twice the rate. Contrary to popular assumptions, India’s forex reserves of $360 billion is not money for jam; it is essentially money borrowed from abroad, with the country’s net external debt now at $480 billion (as at the end of December 2015). The country is paying over $11.5-12 billion in interest on this debt – more than twice what it earns on its forex reserves.

This means we (mostly companies and banks) are borrowing at higher rates and the Reserve Bank is reinvesting the dollars received at less than half the borrowing rates. What good can that be doing us? The difference between the rate at which we borrow dollars and the rate at which we invest it is effectively the premium we pay to avoid a run on the rupee. It is a high price to pay and worth reconsidering.

Three, China, which is the world’s largest holder of dollar reserves, is steadily bringing down its reserves, and secretly investing in gold.

According to this CNN report, Chinese gold imports have surged more than 700 percent since 2010 – and much of it is going under the radar and not reported in official reserves. In 2009, China reported holding 1,054 tonnes of official gold; in 2015, this had risen to 1,700 tonnes, but Bloomberg put the figure at twice that level - at over 3,500 tonnes.

On the other hand, China’s official reserves fell from $3.7 trillion in April last year to $3.2 trillion early this year. This means China spent more than half a trillion dollars’ worth of reserves to correct its economic biases – including its over-exposure to the dollar - in less than a year. China buys around 40 percent of the gold produced every year, and it is also the world’s biggest gold miner.

A plain reading of this news suggests that China is trying to diversify away from the US dollar, and it is not alone.

According to this Bloomberg report, “Russia more than tripled its hoard since 2005 and Kazakhstan raised its every month since October 2012.” A report by Profit Confidential notes that central banks have been continuously buying gold since 2012, and, as at the end of 2013, they held 30,500 tonnes of it, about a fifth of all gold ever mined.

The message for the RBI is clear: it should not get squeamish about buying gold again. It should not tie itself up in knots about sending the wrong message to a domestic audience, which it is trying to wean away from gold. Like every good Indian household knows, gold is the only currency that has held its own in an uncertain world. And the world is nothing if not uncertain right now.

The Reserve Bank should behave like a good Indian and buy gold, just like the Chinese and many other central banks in the world do. Buying when gold is in the $1,200-plus range makes more sense than buying later.