The Hindu Business Line : Return of India’s gold

A week back, the Reserve Bank of India (RBI) surprised the world by buying 200 tonnes of gold for $6.7 billion from the IMF. This is half the total quantity of 400 tonnes that the IMF had decided to sell to raise resources for lending to poorer countries.

This marks a remarkable turnaround from 1991, when the RBI had to pledge gold with the Bank of England to get funds to tide over India’s balance of payments (BoP) problems,. I was the RBI Governor.

CRISIS OF 1991

In 1991, India had approached the IMF for BoP assistance in view of the financial difficulties faced by the country. The International Monetary Fund (IMF) authorities had insisted that India should also put in its resources, such as the gold that India had, to show our earnestness in tiding over the crisis. There was no alternative save accepting the IMF’s suggestion.

At that time, the Government of India’s representatives and I tried to argue that India --being a depository of gold reserves for the IMF — should be entitled to keep the gold required to be pledged within the country . The IMF authorities did not agree. We , therefore, had to transport the gold to London and pledge the same with the Bank of England.

When this transaction was undertaken, the Union Government was headed by Mr Chandra Shekhar, who took the bold decision to approve of the transfer of gold. Mr Yashwant Sinha was the finance minister at that time. I had the opportunity of having a word with Mr Rajiv Gandhi, , whose party was then supporting Mr Chandra Shekhar’s government.

During conversation, he agreed informally that there could be no better way of using the gold than at a time when the country is in difficulty. He asked, “Of what use is gold if it does not serve the national purpose in assisting the country in its difficulties?”

Mr Chandra Shekhar was shrewd enough to realise that there would be political opposition even from within the Congress, leave alone other parties, to the proposal to move gold out of India. In his own sarcastic way,

Mr Chandra Shekhar pointed out that in the Parliamentary elections that lay ahead, Rajiv’s party spokesman would attack the move to gain political brownie points. Be this as it may, the late Mr Chandra Shekhar must be hailed for his bold move to support the RBI’s proposal to pledge gold abroad.

However, the decision brought home the enormity of the economic crisis faced by the country. We had been borrowing in the international financial markets to pay for our crude oil and other essential requirements and our BoP was in trouble. We were fortunate that Mr Chandra Shekhar was succeeded by Mr P. V. Narasimha Rao, and Dr Manmohan Singh took over as Finance Minister. The trauma of the movement of gold set the right backdrop for Dr Singh to push through his bold economic reforms, which were essential to resolve the crisis.

CHANGED SITUATION

The wheel has now come full circle. In the 18 years since the pledging of gold in 1991, the country has moved sufficiently ahead as to be able to buy a substantial sum of gold from the very same institution.

The gold purchase is justified as a means of diversification of foreign exchange reserves, which stands at $285 billion , largely in the form of investments in dollar-denominated debt paper.

Investing a relatively small part of the reserves in gold is a worthwhile risk mitigation exercise. The RBI’s investment of $6.7 billion in gold, is, therefore, more than fully justified.

When Dr Singh, as Finance Minister, explained the decision on pledging of gold, he was asked to bring back the gold at the appropriate time. He promised to do so. He has more than lived up to his promise by bringing back a much larger quantity of gold through the latest purchase.

Will other countries follow RBI’s initiative? Our attention naturally turns to China, which has more than a trillion dollars as forex reserves. China is perhaps a large producer of gold. If it wants to diversify into gold, it can buy its own gold, ruling out outflow of forex.

China’s forex reserves are so large that to make a difference to its composition it will have to buy a very large amount of gold — almost the world’s annual supply. Besides, China is adopting different tactics to minimise risks. It is doing its best to diversify its forex management by investing its reserves in acquiring natural resources, such as crude oil reserves, natural resources and farm land in various countries.

TIMING OF PURCHASE

RBI bought the gold from IMF when its price was ruling high. The offer of sale by IMF, which was too good an opportunity to miss, came only now. Such opportunities for large-scale purchase of gold come once in a lifetime. If RBI had entered the market to buy such a large quantity of gold, the exercise would have been messy and led to a spike in prices.

The RBI could have perhaps tried to diversify into gold at an earlier stage when prices were lower. But the move to buy gold now was appropriate as the IMF needed the resources and RBI a hedge against a falling dollar.

The question has been posed as to whether the RBI will resort to selling some of its gold in the open market in India with a view to mopping up some of the liquidity in the system. This will also help to lower the price of gold in the market. This is an option the RBI may consider, depending on whether it has the mechanics of gold sales properly worked out.

There is a more important lesson that the latest episode has emphasised. The fact that India was able to undertake this large purchase without impacting the reserves or the economic conditions shows the distance we have travelled since 1991.

We have to pledge ourselves to go further on the course of reform on the lines indicated by the Prime Minister at the recent World Economic Forum meeting .

Related Stories:
RBI buys 200 tonnes of gold from IMF

More Stories on : Gold & Silver | RBI & Other Central Banks | Insight | S Venkitaramanan

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Engg, management grads see clerical job as a ‘stopover’

Arabian Sea ‘low’ persists, may bring more showers

Telecom operators want lock-in policy relaxed

UltraTech agrees to 4:7 swap for Samruddhi merger

Taj hotel heritage wing to open doors soon

Oman Oil picking up more stake in BPCL’s Bina refinery

States asked to expedite power-for-all plan

Opto Circuits India (Rs 219.9): Buy

Day Trading Guide

Despite some profit taking, gold may move up

Gold futures may test resistance levels

Return of India’s gold

Profit booking may check market momentum

Writing of options involves margin requirements

FIIs reduce holding in one-third of BSE 500 stocks