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Will India increase its gold reserves?



-- Posted Friday, 1 December 2006 | Digg This ArticleDigg It!

There has been a lot of anticipation and euphoria among the gold bugs around the world on the news that a former Deputy Governor of the Reserve Bank of India and Chairman of the Committee on Fuller Capital Account Convertibility has suggested to the Reserve Bank of India to increase the proportion of gold in the country's foreign exchange reserves. Mr. S.S. Tarapore, who has been a long time admirer of gold, said that gold as a reserve asset has a longer and more enduring history than flat money, and thus deserved a better representation in the country's forex reserves.

During last couple of years the forex reserves have risen significantly while the gold reserves have remained where they ware. With the significant rise in the forex reserves and a stagnant holding of gold tonnage, the proportion of gold in forex reserves has come down to a pitiful low of 3.6 per cent. 

Even more worrisome is the present structure of Indian forex basket. The foreign exchange reserves are invested in multi-currency, multi-asset portfolios. As at end-March, 2006, out of the total foreign currency assets of US$ 145.1 billion, US$ 35.2 billion was invested in securities, US $ 65.4 billion was deposited with other central banks, BIS & IMF and US$ 44.5 billion was in the form of deposits with foreign commercial banks. Although this equation is similar to international practices in this regard, this is not the best thing to do right now. As any forex trader with 2 weeks of trading experience knows, the greenback is tottering at its hind legs, and any country or corporation or individual who keeps most eggs in greenback lined basket is bound to lose many of them.

This is what has been worrying the former deputy governor. Interestingly his suggestion has come when the central banks of many countries are considering of re-engineering their reserves. Recently there has been a lot of talk about China diversifying its forex reserves. Though nothing has been declared officially yet, it is assumed that China will certainly increase gold reserves, bringing them at par with those in the OECD countries.

Russia has also been steadily increasing its reserves, and so has been Argentina. Last year there was news that many other Latin American countries were considering of doing the same. That so many countries are bolstering their reserves proves that the move is not unprofitable. The rising gold prices during last two years add to that sentiment.

Most of the countries are looking a switch over to gold since favoring one fiat currency over another is nothing but Hobson's choice. The very problems that haunt the US dollar also plague the euro, pound or yen. No doubt there are not many choices left for Indian financial managers to choose from. If the US dollar is hit by its dwindling economy, the bursting housing bubble and the soaring trade and current account deficits, other currencies are no better. "With reserve currencies limited to the US dollar, the euro, the yen and the sterling, the possibilities of diversification are very limited," said Mr. Tarapore. Hence the suggestion for gold.

The suggestion is even more valuable since any investment in gold would be a fantastic move to preserve country's wealth. This is particularly important since the Indian Rupee is not in the pink of health. Although last two years it has shown stability, the rupee depreciated by 1.4 per cent against the US dollar, 5.5 per cent against the euro, 9.0 per cent against the pound sterling and 0.5 per cent against the Japanese yen during the current financial year so far (up to October 27, 2006). According to the experts, this is nothing, and once the tide turns against the Indian economy, the rupee may depreciate against most important currencies as well as gold. Many observers feel that the rupee has been holding on simply because of increased pace of foreign currency inflows in the Indian stock markets, and the moment the stocks take a beating, the boat of Indian currency would begin to rock.

In fact the rupee has enough inherent weakness and it is likely to depreciate even against the ailing US dollar during the coming months/years. Even when the US dollar depreciates against the Yen and the Yuan - simply because a whole lot of US trade deficit is due to trading with Japan and China - the Indian rupee is unlikely to gain from the process. In fact the Indian economy is likely to suffer since the price of imports will go up. Oil, which is becoming a very big drain on forex, is likely to be the Achille's heel in the economy.

In short there are enough reasons why India must increase its gold reserves. However there are not many chances this advise will be heeded. First of all, Indian forex reserves have gone up, but they are not enough to give a level of comfort to those who are responsible for managing them.

The traditional trade-based indicator of reserve adequacy, viz, import cover of reserves has been falling of late. The import cover, which fell to a low of 3 weeks of imports at end-December 1990, rose to 17 months of imports at end-March 2004 but came down drastically to 11.6 months as at end-March 2006. This is due to the fact that Indians are getting increasingly addicted to the imported goods, be it laptops, plasma tvs, dvd players or cars and other fancy gadgets. This has also been due to the increase in oil import bill, part of which is due to increased imports and part of which is due to the increased prices.

Besides, increasing gold reserves is not an issue on the mind of Indian politicians right now. The government is unable to rein in the fiscal deficit in spite of the pressure from Fiscal Responsibility and Budget Management Act, and has difficulty arranging finance for most rudimentary expenses. Most of the state governments are buried under a mountain of debt, so much so that some states don't have money to pay to their employees.

Also investment in gold is usually done by countries or individuals who have a vision, and Indian politicians and bureaucrats are usually notorious for shortage of it. Investing in gold, specially at current prices requires an out of the box thinking and guts to take a bold decision. If the gold proportion of the forex reserves were raised to 10 per cent of total reserves ,- as is the case in many developped countries - it would require a forex outgo to the tune of about $15 billion at current prices. The financial managers of this country can't conceive of spending such an amount on something that is considered "non-dividend-non-interest" paying asset.

All said and done, there is very little chance of the suggestion being received warmly in the upper echelons of Finance Ministry.

  

©2006 Shailendra Kakani. All rights reserved.

Shailendra Kakani is the Research Head of Commodity Research Group, Bombay, India, and the Managing Editor of www.commodityresearch.in . He can be reached at editor@commodityresearch.in . or at

+91 98678 33034
Bombay, India


-- Posted Friday, 1 December 2006 | Digg This Article




 



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