Should India pile its reserves with gold?

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Should India pile its reserves with gold?

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• RBI and Gold: When the Indian economy hit rock-bottom in 1990, the RBI was forced to pledge gold with the Bank of England, to tide over India's balance of payment trouble. Later in 2009, 200 tonnes were purchased by RBI from IMF. First brought gloom, second cheer.
• Accumulating gold: RBI has been changing its stance towards gold, and since 2018, gold reserves are rising steadily.

1. From Dec 2017 to March 2021, it added 137 tonnes to forex reserves
2. Gold as part of forex reserves rose from 5% in Dec 2017 to 7% now
3. Some other Emerging Economies too are doing so, to reduce the risks from too much US dollar exposure. However, there are limits.

• From 2009 to 2017: RBI didn't buy gold after its 200 T purchase in 2009, and it stood at 558.1 T (Nov 2009 to De 2017). From 2018, it bought 40 T annually, and even in 2021 first quarter, it bought 18.7 T. Today's total is 695.3 T, tenth globally. India is now far higher than most emerging markets, except China.
• Why buy gold: If a nation wants to reduce the power of US in global economy, one way is to reduce the dollar usage in external transactions, and dollar component in forex reserves.

1. India's main fear for now is the possible dollar depreciation coming ahead, which may cause capital losses to it
2. RBI built a huge forex reserve since 1991, due to large FPI and FDI inflows (and a third are held in the form of US treasury securities)

• Story since 2018: Two things happened - (i) the USD fell sharply in 2017 due to trade war with China, and as commodity prices dropped, dollar assets were sold, and (ii) yields on US treasury bonds rose fast from Sept 2017 to March 2018. Together, these two would hit value of US Treasury securities' value (held in forex reserves by RBI). As gold was rising since Sept 2018, RBI would have been emboldened to buy more.
• Stimulus and interest rates: Since the US govt rolled out huge stimulus in 2020 and 2021 also, USD would weaken eventually. And, the interest rates are near zero. So RBI sees sense in diversification. World Gold Council surveys indicate many central banks' desire to do so.
• How much gold to hold: There are some practical issues in holding too much gold -

1. Volatile gold prices can lead to capital losses (30% drop in 2013, for example). Forex reserves are actually a buffer to fight external account crises and support India during extreme stress. So caution is recommended!
2. Experts question gold's ability to be a safe haven in the long run (as an effective hedge)
3. Selling gold at good prices, in large quantities, is tough
4. India's forex reserves need to be built in terms of currency-composition of external trade, currency of foreign borrowings, key currency with which INR is linked, etc.

• Summary: Go carefully, slowly, measuring the risks and rewards at each stage. Not too much, not too little.

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