Why is the RBI focusing on Gold Reserves?

The Reserve Bank of India (RBI) has been focusing on increasing its gold reserves. Not only the Indian central bank but the same is done by other countries' central banks. What is the concept of gold reserves, and why is the RBI so focused on it? This article is for you if you are looking for answers to these questions and other related information about gold reserves.

Concept of Gold Reserves in India

India has a long and strong relationship with gold. There are multiple reasons for holding gold reserves. You may already know that the RBI also has a forex reserves component. Foreign current assets are a large part of it. The second-highest allocation is gold. Gold reserves help the central bank diversify its foreign exchange reserves.

Global status of gold reserves

The United States reigns supreme when it comes to global gold reserves. Not only this, the US holds nearly as much gold as the combined reserves of Germany, Italy, and France, which occupy the following three spots. India's gold reserves help it make it to the top 10 list. 

You should know that the exact amount of gold some countries hold can be a secret. We have resources like the World Gold Council that offer estimates, but confirmation can be difficult. Here are the gold reserves held by different companies (in tonnes).

Why does the RBI focus on increasing gold reserves?

The RBI has been increasing its gold reserves for a few years now. However, in the last few quarters, the increase in gold reserves has increased significantly. One of the prime reasons for this is the decline in confidence in dollar assets among central banks. Even the US Treasury Department data suggest that the non-US central banks' holdings of US Treasury bonds have dropped from 50.1% in January 2023 to 47.2% as of January 2024. Here are some other reasons behind the increase:

• Diversification and de-dollarization: The RBI wants to diversify its foreign exchange reserves and reduce dependence on the US dollar. Gold offers stability and isn't directly tied to the performance of any one currency. It can be especially valuable during times of economic uncertainty or fluctuations in the dollar's value.
• Hedge Against Inflation: Gold has a reputation as a hedge against inflation. When the value of currencies weakens due to inflation, gold tends to hold its value or even increase. It protects the purchasing power of India's foreign reserves.
• Safe Haven Asset: Gold is seen as a haven asset during global economic crises, which is currently the state we are in because of wars. When other investments become volatile, gold tends to remain stable. Having a large gold reserve provides a buffer for the economy during financial turmoil.
• Confidence Building: A large gold reserve can inspire confidence in the Indian economy from foreign investors. It signals a strong financial position and stability, potentially attracting more foreign investment.
• International Transactions: While less common today, gold can still be used for international transactions. Holding a gold reserve allows India to settle debts with other countries if needed, even if those countries aren't willing to accept rupees.

Purchase to reserve ratio in India

The purchase to reserve ratio in India's gold reserves refers to the proportion of gold bought by the country's central bank, the Reserve Bank of India (RBI), relative to its total gold reserves. The ratio provides insight into the RBI's strategy for managing its gold holdings and its stance on gold as a reserve asset.

You can calculate the ratio using the following formula:

Purchase-to-Reserve Ratio = (Total Gold Purchased)/ (Total Gold Reserves) × 100

Where:

• Total gold Purchased: The amount of gold acquired by the central bank through purchases or acquisitions within a specific period.
• Total gold Reserves: The total quantity of gold held by the central bank as part of its official reserves.

Historically, India has been one of the largest consumers of gold globally, both for cultural reasons and as a store of value. The RBI periodically purchases gold to diversify its reserves and mitigate risks associated with fluctuations in currency values and other economic factors.

The purchase to reserve ratio fluctuates over time based on various factors, including the RBI's assessment of global economic conditions, inflationary pressures, currency stability, and geopolitical risks. Generally, a higher purchase to reserve ratio indicates increased confidence in gold as a reserve asset and a strategic decision to allocate more resources to gold purchases.

Impact on Gold Rates

India's gold purchases, while significant domestically, are a relatively small portion of the global gold market. It means the RBI's buying may not have a huge direct impact on global supply and therefore, gold prices. However, there are indirect influences:

• Rupee Strength: If the RBI is buying gold to diversify its reserves and reduce dependence on the US dollar, a stronger rupee could result. It could make gold imports cheaper, potentially increasing domestic supply and putting downward pressure on prices.
• Market Sentiment: The RBI's actions can influence market sentiment. If the increase in reserves is seen as a positive sign for the economy, it could lead to a broader increase in investor demand for gold, pushing prices up.

Overall, the impact on prices might be more noticeable in the short term due to immediate market reactions. Long-term effects are harder to predict. Also, the RBI's reasons for buying gold can influence the impact. If it's to hedge against inflation, the price impact might be different than if it's for diversification.

Before you go

We hope the article was useful for you and that you learned something new. As per experts, the total gold reserves for India are expected to rise even further from the current levels due to the appreciation of gold prices and the overall increase in reserves. However, the buying discussion is driven by a lot of factors, and the central bank may change the plan if something changes.