Tarapore wants RBI to hold more gold in kitty

The government should allow the Reserve Bank of India (RBI) to increase the share of gold in the country's foreign exchange reserves to diversify risks arising from volatility in global currencies and also to make it work as a hedge against global inflation, said S S Tarapore, former deputy RBI governor & the head of the committee on Fuller Capital Account Convertibility.

He also sought a change in the "antiquated belief" of India's polity that RBI's gold transactions in the market are bad, while frequent transactions in dollar, euro, yen and pound are good. "The time has come to shed our phantom fears on the gold transactions of the RBI," said Tarapore.

With reserves currencies limited to dollar, euro, yen and pound sterling, the possibilities of diversification are very limited. Gold is unique, in the sense it is both a commodity and a store of value, Tarapore said, addressing a meeting on foreign exchange management today.

While there is a significant rise in the foreign exchange reserves, the stagnant holding of gold (in quantity) in the country's forex reserves has resulted in the dwindling of the share of gold to as low as a 3.6 per cent.

If the gold proportion of the RBI's forex reserves were cautiously raised to say 10 per cent of the total reserves, it would require additional purchase of gold by the RBI of $10-11 billion.

The gold proportion of the reserves would be a bedrock which will not be used in early stages of any drawdown of reserves or when there are periodic fluctuations in the reserves, he said. Gold invariably moves inversely with the dollar and also rises in value when international inflation gathers momentum.

Thus, there are strong reasons for holding reasonable proportion of Indian foreign exchange in reserves in gold, he said. The in and out movements in the RBI gold reserves will be based on the central bank's perception of gold price and not the day to day needs for forex.

There are concerns that the price of gold fluctuates but so do value of currencies. There are long term advantages in raising the proportion of gold in foreign exchange reserves.

The RBI's portfilo managers should also focus on the value of holdings of different currencies in terms of gold. This will clearly shows that gold has held its own over the secular period.

Before, the RBI moves over to an active gold policy, the fears of gold in the polity have to be removed. The costs of the present passive gold policy and what a proactive gold policy would deliver if the RBI were to undertake two way transactions in gold should be clearly spelled out.