Under a programme of gold sales limited to 403.3 tonnes during October 19-30, 2009, the International Monetary Fund (IMF) sold 200 tonnes to the Reserve Bank of India (RBI) for $6,699 million or Rs 31,462.88 crore at an average price around $1040 per Troy ounce.

If one takes the value of gold now at $1,740 per ounce and the exchange rate at Rs 45 to a dollar, by selling the 200 tonnes the RBI could make a profit of about Rs 20,000 crore. Besides the financial gain, there are other advantages. At the end of the RBI's accounting year (June 30, 2012) it will be transferred to the government along with the other surplus, contributing substantially to the reduction in fiscal deficit in 2012-13.

BENEFITS OF THE MOVE

The forex reserves will not be affected, the decline in the gold value being made up by the rise in foreign currency assets. The pressure on the market due to government borrowing will be lessened and there will be a saving in the interest cost implied in an equivalent amount of floatation of government securities. The transfer of the amount does mean the creation of money but it could be adjusted against the desired estimate for the growth in money supply. The sale would also take care, in whole or part, of any planned disinvestment programme of government.

It is likely to result in fewer objections from the Opposition and trade unions than in the latter case. Further, it will forestall the possible adverse impact on the market due to money flowing from the bank accounts of the buyers of the enterprises to government account in RBI, creating a liquidity shortage. It is not likely to be criticised as selling family jewels in distress.

Many Western countries have sold the metal. There have been three Central Bank Gold Agreements (1999, 2004 and 2009) for the sale of official gold by the ECB member banks. The RBI Act requires only that its aggregate value of gold coin, gold bullion and foreign securities should not at any time be less than Rs 200 crore, of which the value of gold should be at least Rs 115 crore. The current position is comfortable.

LENDING OUT GOLD

The other option is to lend at least a part of the holdings to bullion banks. Often, the mining companies borrow to fulfil their commitments when there is a shortfall in production. The lease transactions are totally opaque and no institution has an idea of the total world turnover in a year. It is only the central banks of Switzerland and Portugal which mention the leases in their Annual Reports. Others keep them off their balance sheets.

However, gold lent continues to be reckoned as reserve. Estimates of gold lending by central banks in 2008 ranged from 4,000 tonnes to 16,000 tonnes, the latter accounting for about a half of the total official holdings, including those of the IMF and the Bank for International Settlements (BIS).

The gold lease market is the equivalent of the carry trade in currencies. It provides an arbitrage opportunity to borrowers to sell the gold and make an investment. The carry return is the return on the bonds (LIBOR) minus the gold lease rate. The lease rates (in percentages) on August 12, 2011 were 0.08, 0.21, 0.47 and 1.05 for one, three, six and 12 months, respectively.

The difference between LIBOR and the lease rate determines the contango, which is influenced by credit market conditions. Because of the inherent strength of the gold market contango has prevailed more often than backwardation.

The Bank of England (BoE) holds gold on behalf of many central banks, Bank of Korea being the latest, and often acts on their behalf in market transactions besides being a lender itself.

THEN AND NOW

The sale or leasing out of gold is not likely to encounter any opposition of the type one saw during the Gulf Crisis in 1991 when RBI raised a forex loan from BoE and Bank of Japan on the security of the metal kept with the former.

The Opposition then accused the government of mortgaging the family jewels; but if the RBI had not done so, India would have defaulted on the instalment repayment of a foreign loan that would have done immense damage to its reputation in the international markets.

I accompanied the then RBI Governor, Mr S. Venkitaramanan, as his Adviser and as a member of the Indian delegation to the 1991 Annual Meetings of the IMF and the World Bank in Bangkok. He met the Deputy Governors of IMF and World Bank with a request that the pledged gold might continue to be with the BoE even after the loans were repaid as one did not know whether another occasion would arise for a similar borrowing from the central banks. The two banks agreed to consider the matter.

According to a recent RBI report, it held 557.75 tonnes of gold, forming about 7.5 per cent of the total foreign exchange reserves in value terms, as on March 31, 2011.

Of this, 265.49 tonnes were held abroad (65.49 tonnes since 1991 and 200 tonnes since November 2009) in deposits/safe custody with the BoE and the BIS. It is not clear whether the BoE has been entrusted with the management of the stock in terms of leasing.

However, the report refers to the rate of earnings on foreign currency assets and gold being 2.09 per cent during July 2009-June 2010.

(The author is a Mumbai-based economic consultant.)

More Like This

Published on August 24, 2011