Smart gold deal by RBI

(D. H. Pai Panandiker is President of RPG Foundation. The views expressed in this column are his own)

By D.H.Pai Panandiker

The Reserve Bank of India (RBI) grabbed 200 tonnes of gold offered for sale by the IMF at the going market price of $1045 an ounce. That gold will be part of the foreign exchange reserves of RBI.

The IMF had to sell gold because it needed money in order to reorganize its finances and to step up concessional loans to the poorest countries that had been hit by world recession. Further, the IMF had to ensure that its operations do not disrupt the market for gold and therefore preferred sale to central banks that generally buy gold for keeps.

Central Banks don’t speculate. Obviously, the gold bought by the RBI is for changing its asset portfolio. The $6.7 billion spent on gold was from investment in securities issued by foreign governments that form the bulk of the foreign exchanges reserves. These securities earn very low rate of interest, if at all. The interest rate in the US and Japan is close zero.

Although the composition of RBI’s foreign exchange reserves is not an open information, it appears that about 50-60 per cent of the reserves are in US dollar securities. The potential risk is that the dollar may depreciate further. Already the dollar had been down 7 per cent against the euro and 11 per cent against the yen in the last 6 months.

It is feared that, with the pumping in of cash by the Fed to avert the impending financial catastrophe last year, the dollar may plunge yet more in future.

The RBI’s gold reserves have been low compared to the gold component of reserves of many other central banks or even its hold reserves in the past. When the IMF took the decision to sell gold it was therefore expected that India will be a potential customer. Even with the additional 200 tonnes in the vault, the gold component of RBI foreign exchange reserves would be only 6 per cent.

The only yield from gold is its appreciation. In recent years, gold has been a favoured asset even among individual investors because of greater uncertainly in the real estate and stock markets. The international price of gold has been consistently rising since 2003. From $400 an ounce in 2004 it jumped to $700 in September 2007 and to $1000 in September 2009.

Gold as a reserve asset can be, up to a point, a better alternative to government securities in foreign exchange reserves. The price of gold is likely to rise further in future for a variety of reasons.

First, there is greater confidence in gold by the public because of the bitter experience from the recent financial crisis. Second, there is loss of confidence in the dollar which is tempting central banks to hold gold instead. Third, cost of mining gold is rising sharply.

It is therefore expected that gold price will double in the next 10 years. The RBI deal with IMF to buy gold was undoubtedly smart.

(You can e-mail Dinker H. Pai Panandiker at: dpanandiker@gmail.com)