RBI’s Chakrabarty downplays ‘hedge against inflation’, ‘safe asset’ attributes

The steep rise in gold prices over the past few years indicates that the risk involved in investment in gold has heightened, cautioned K. C. Chakrabarty, Deputy Governor, Reserve Bank of India.

This is a fact which is not recognised by people, he said at a Workshop on Financial Literacy.

Some basic concepts are not fully appreciated even by seemingly literate groups, resulting in assumption of excessive risks.

“One example that I often quote about the widespread financial illiteracy is the theory being floated around by the so-called ‘financial advisers’ about investment in gold being a ‘hedge against inflation’ and a ‘safe asset’,” said the Deputy Governor.

Given that the price of the yellow metal has surged in the last few years, Chakrabarty flagged the risks involved in investing in gold.

According to the RBI’s Financial Stability Report, the price of gold carries an ‘uncertainty premium’ arising from risk aversion among investors in recent years. This has caused an above-normal return that is not sustainable in the long term.

Since Indian households hold a significant quantity of gold, they face the risk of a correction in gold prices.

There has been a reduction in the share of financial assets in household savings as households’ preference for physical assets and valuables like gold seem to be rising, thereby adding to the pressure on the current account deficit (CAD). This is a worrying factor, said the report.

CAD arises when a country’s total imports of goods, services and transfers is greater than exports.

Curbs on gold demand

To tamp down the demand for gold, the Government has upped the Customs duty on gold imports from 4 per cent to 6 per cent.

Further, a RBI working group has suggested introduction of gold-linked financial products, which are not backed fully in physical form, to help reduce gold imports. Inflation-indexed bonds are also in the works to offer investors a hedge against inflation and dissuade them from gold investments.

According to the RBI’s Macroeconomic and Monetary Developments document for the third quarter, continuing large imports of oil and gold have resulted in a deterioration of the trade balance.

Further, low growth and uncertainty in advanced economies as well as emerging market and developing economies continued to affect exports in the third quarter of 2012-13.

The deterioration in trade balance (with imports outstripping exports) has led to the CAD-GDP ratio reaching a historical of 5.4 per cent in the August-September quarter of 2012-13.

Gold imports continue to account for a large part of India’s CAD. Also, the country accounts for a quarter of the world demand for gold.


(This article was published on February 5, 2013)
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