Wary central banks binge on gold, sending prices soaring
3 min read . Updated: 04 Feb 2023, 09:00 AM IST
Premium- Central banks’ view of gold as an asset has been changing and gold purchases are being made with a long-term view. These banks have been buyers of gold every year since 2010 after being net sellers in the two decades preceding the global financial crisis of 2008
Gold prices have risen to a new lifetime high in India in response to certain customs duty provisions in the Union Budget. But even before this, international prices were at a decade high last month, having rallied 15% since November. The surge is driven by the highest demand for gold from central banks in 55 years.
Gold prices rarely rally when monetary policy turns hawkish, interest rates are rising and the dollar is also strong, as higher interest rates on other investment options makes the precious metal less attractive. That’s because unlike bonds, gold provides no regular returns.
But there’s an additional factor at play in the ongoing phase of monetary tightening. With Russia’s unending war throwing geopolitics into turmoil, the US dollar has ceded status to gold as the preferred safe haven for central banks. Their hectic purchases are a consequence of the fears triggered by Western countries’ sanctions on Russia soon after it attacked Ukraine nearly a year ago. These sanctions effectively froze the bulk of Russia’s war chest of foreign exchange reserves.
Not surprisingly, among the biggest buyers are the central banks of Turkey, China, Qatar, Egypt, Iraq and the UAE. The Reserve Bank of India (RBI) also added to its gold reserves but at a slower rate. It bought 33 tonnes in 2022, which was 57% less than the previous year. The only developed market economy central bank that bought gold in 2022 was Ireland’s.
The People’s Bank of China is also reportedly buying gold for the first time since 2019 to reduce the risk of its foreign exchange reserves being frozen over its close ties to Russia.
New data from the trade body World Gold Council shows that 4,741 tonne of gold was bought in 2022, which is 18% more than in the previous year, the biggest quantity since 2011, and the second-highest in history since 1950, when the dollar was still pegged to gold.
Originally, like many other currencies, the rupee was also backed by gold holdings of the RBI. The original Reserve Bank Act prescribed a proportional reserve system under which at least 40% of the total note issue was to be backed by gold bullion and sterling. But after the gold standard broke down, central banks including the RBI began to back note issues with a mix of domestic and foreign securities, and gold.
Ever since then, central banks’ view of gold as an asset has been changing and gold purchases are being made with a long-term view. These banks have been buyers of gold every year since 2010 after being net sellers in the two decades preceding the global financial crisis of 2008. Central banks collectively bought more gold last year than they have in any of the past 55 years, scooping up 1,136 tonnes or more than twice the 450 tonnes they picked up in 2021 and proving to be the main cause of the surge in demand.
In November 2009, about a year into the global financial crisis, when gold reserves were about 3.5% of the RBI’s forex reserves, then governor D Subbarao decided to buy 200 tonne of the precious metal from the International Monetary Fund for $6.7 billion. The idea was to diversify the risk of India’s reserves, as gold prices and the value of the dollar usually move in opposite directions. The IMF had announced it was planning to sell some gold to help finance its lending to low-income countries struggling with the impact of the global financial crisis. Its offer was on a first-come-first-served basis on the open market.
In 1991, when Subbarao was a joint secretary in the finance ministry, he had signed an agreement on behalf of the government, authorising the RBI to pledge India’s gold reserves to secure the foreign exchange required to avert a default in face of the Balance of Payments Crisis.
He decided to pick up 200 tonne of gold from the IMF for the RBI’s reserves despite the logistical challenges this would present, given the requirement of high secrecy. Any leaks could move the market prices of gold, adding to the cost of the transaction, so nobody outside the RBI team working on the purchase was told about it. Subbarao informed Prime Minister Manmohan Singh and Finance Minister Pranab Mukherjee about it a few days after it was completed (on November 3, 2009), when he met them in some other context.
