India’s tryst with gold in a new economic order
In a world flooded with central bank liquidity yet fraught with economic uncertainty, gold will preserve value for the Reserve Bank of India.
For millennia, the people of India have found value in accumulating gold, using it as a hedge through long cycles of economic and geopolitical change. Over a thousand years ago, India had its own “gold standard” wherein temples acted as banks, financing business activity and collateralizing debt. The loot of the gold by invaders from Central Asia ultimately decimated the economy, reducing its competitiveness in the global world order as capital formation plummeted. Today, as the country steps into a new economic paradigm, lessons must be learned from the past. This paradigm, defined by instability in the world order, low international interest rates and potential devaluation of global fiat currencies has seen gold prices break new highs. Preserving wealth is crucial at this juncture, and the Reserve Bank of India (RBI) would be well placed to gain from topping up its gold reserves.
A golden opportunity
Precious metals and tech have been the standout performers in the global financial markets this year, with increased central bank liquidity and stimulus filtering through markets which themselves remain uncertain of the immediate future of traditional sectors. While cyclical rotation is expected at some point when vaccines are rolled out and the world returns to a semblance of normalcy, the structural shift in monetary policy and belief in a backstopped economic system will cast a long shadow over the sustainability of competitive free-market capitalism seen in the pre-Covid era. This sentiment is already taking form through increased national security concerns pushing protectionist moves which will likely result in a reduction in apparent positive externalities experienced through lopsided globalization of the yore. Worries over future inflation risks, against which gold has traditional been a hedge, may not materialize in the way seen in previous economic cycles. Technology has played a significant deflationary role over the last two decades, and going forward, this can be expected to only continue in light of the exponential growth in frontier technology solutions. The question then arises, as to why, broadly speaking, the forward guidance for gold is positive, and to what extent India can benefit by stocking up on the yellow metal.
Why gold reserves are important for India
Inflation in developed nations remains largely muted and the good and services consumed are sharply impacted by deflationary technologies. Infrastructure-led growth in import dependent developing economies like India, however, is vulnerable to exogenous price shocks. While the government’s effort to double down on nurturing domestic manufacturing should stave off some of these potentially inflationary risks down the line, import dependency on raw material and finished goods in the medium term, poses concerns.
Yet, it is not only against this that gold will act as a value store, but it is also in the face of excess liquidity injection that has resulted in a large volume of capital searching for limited homes. Precious metals, by nature of being rare, are sought after for in the physical market to the point of a disconnect between the physical and paper prices. Importantly, as US debt rises steeply in the face of the pandemic, questions are being raised as to the future strength of the dollar.
With foreign exchange reserves topping $500 billion, the RBI has been active in purchasing bullion. From 360 tonnes in 2009, it slowly inched its way up to around 550 tonnes in 2017. A fresh push has now brought this to nearly 650 tonnes this year.
Private consumption has dropped across the world after Covid hit, and the pronounced drop in Indian retail buying – which typically is around 20 percent of total global purchases – has not prevented prices from appreciating. Much of this can be attributed to purchases by central banks, wealthy investors and asset management firms. The flight to safety is real and appears that it is here to stay for the foreseeable future. Structural dollar weakness can pose a threat to cash holdings and it becomes imperative that diversification into bullion takes a central role in India’s plan to increase the share of gold in its total reserves going forward.
Surya Kanegaonkar is a commodities professional with ten years of experience in research and trading for a hedge fund, utility and miner.