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RBI Will Sell Gold in India, Buy Gold Abroad, Ease Supply

With the large duty on Gold imports, and very large gold requirements in an inflationary economy, the issue of “how can we reduce Gold imports” has driven RBI to an interesting solution.

Economic Times reports that RBI will swap Gold it owns in India for Gold deliverable in London. The official reason is that the Gold is sought to be replaced with that of a purer variety.

Here’s how the proposed swap scheme between RBI and banks would work: RBI will give delivery of gold from its Nagpur vault to banks in India while taking delivery of gold from banks in London.

But the gold that RBI would give to banks in India could be of a slightly inferior quality compared with the ‘London deliverable’ purer gold that it would receive from banks in London. The banks will deposit the gold in London in RBI’s account with Bank of England.

But what does this swap really do?

Ease Gold Supply in India Without Hitting CAD

Since RBI will sell gold in India to Banks who can sell onward to jewellers, the supply issues in India will ease. Currently, Banks import Gold for jewellers, who have to pay upfront, and then they can only reimport another batch if 20% of the last batch has been exported. And then, there’s a 10% duty on imported gold.

If the RBI were to swap, for instance, 10% of it’s gold, that’s an additional 50 tons of gold (1/10th of its holding) that would be 50 tons less that was imported.

In context, that’s about a month’s requirement of imports.

Why will it not impact the CAD?

Effectively, Swaps Dollars for Rupees, Contracts Money Supply

When RBI buys gold in India it will receive rupees. The purchase in London will be paid for in Dollars. Those dollars are already owned by the RBI as forex reserves. So effectively, the RBI will sell dollars it owns and the rupees it receives will go out of circulation.

In that context, the quantum of gold sold will impact money supply, a little bit. India owns $21 billion of gold, worth about Rs. 120,000 cr. (1.2 trillion), so a 10% contraction is about Rs. 12,000 cr.

A reduction of money supply by 12,000 cr. is not a big deal, and can be replenished easily; the RBI routinely buys dollars by printing rupees anyhow, and it can do an OMO auction to buy bonds.

Capital Mind View

This is good for Gold companies, but only if the quantum is known. If the RBI does this for tiny amounts, it’s insignificant. If it swaps more than 50 tons, it will help ease supply pressure in the next 6 months.

In any case we expect a graded withdrawal of limits on gold imports and the import duty over the next year. In fact, we expect an announcement of the process in the budget, followed by RBI in it’s next Policy statement in August.

If you ask us about how it impacts markets, then our answer in the current situation is: everything will impact the market positively nowadays. There is no news that can even be considered remotely negative. So, that.

  • Vishal says:

    Liked with way you have ended your article….. The mood in the market is such that all news are positive news!!

  • Siddharth says:

    Not a good news. Effectively, gold going out of the country and being given to BoE. Last time I heard, German Bundesbank wasn’t able to repatriate its Gold with US Fed with much success. I am not a conspiracy theorist but doesn’t make sense to me that a central bank would like to contract money supply with Gold (which can be easily be achieved by repos) . And also, a central bank flooding market with Gold and hence possibly reducing consumption INR available for other things (Car, etc)

    • Good point on the BoE trust issue. I also agree that we should transition our gold to Indian vaults.
      Contracting money supply is a byproduct. Think of this as a process that involves buying gold abroad with the forex reserves, selling it locally, and eating up the rupees. Effectively money supply of rupees will reduce, that’s all, total gold on the balance sheet remains constant.

    • D_Rama says:

      Correctly observed by @Siddharth. In effect, RBI is selling physical gold and purchasing paper gold. You can bet you socks that the gold in Bank of England vaults are re-hypothecated many times over. RBI will never actually get its hands on that gold.
      I would be curious to know exactly which “banks in India” would be taking this gold. I would not be surprised if these “banks in India” turn out to be actually branches of Banks in London. “Inferior Quality” of gold is nonsense. Gold is gold, it doesn’t lose value just because its purity was reduced from 99.99% to 99.6%. Whereas swapping physical stocks for paper promises is a completely different matter!
      I think the key point is in the last para of ET’s article: “in 2009, RBI bought 200 tonnes of gold from the IMF”. BoE probably wants some of the physical stocks from that stash. RBI was asked to capitulate probably because UK was one of the first supporter of you know who.

  • Siddharth says:

    Yup , Total Gold figure remains constant. Probably helps CAD too. But reducing Gold price via selling like this can cause capital calls on middle class etc. Still unsure why they are doing this (other than CAD and knowing that this is not a marriage season or diwali.)

  • xyz says:

    This is the reason why Indians buy gold in their personal capacity. Can they trust their government, which comes up with such hare-brained schemes to get rid of physical gold?