Higher central bank gold reserves reduce sovereign credit risk: IGPC Study

Central Bank gold reserves can reduce the sovereign credit risk of a country in international markets, reveals a study by the India Gold Policy Centre (IGPC) at the Indian Institute of Management – Ahmedabad (IIM-A).

The study reveals that while growth-oriented macro-economic policies can reduce sovereign risk, gold holdings of the country’s Central Bank have a strong impact during turmoil in global financial markets.

In 2020, Moody’s downgraded India’s sovereign rating to Baa3, highlighting its weak fiscal position as the primary cause of credit restriction.

In this context, Arvind Sahay, Chairperson, India Gold Policy Centre, IIM-A, said, “Due to necessary countercyclical fiscal stimulus and a build-up of government debt during the Covid-19 crisis, sovereign credit ratings of both advanced and emerging market economies have come under pressure.”

“The findings of this cross-country study suggest that higher Central Bank gold reserves can help in stemming a further deterioration and provide support to the credit ratings of countries such as India,” he added.

In the current scenario, the findings seem to have positive implications for India.

IGPC study

IGPC claims it to be a first-of-its-kind study of global markets conducted by the team of Sawan Rathi, a doctoral student in Economics, Sanket Mohapatra, IIM-A faculty in Economics, and Sahay.

The researchers considered five-year sovereign credit default swap (CDS) spreads for 48 advanced and emerging market countries over a 20-year period, from 2000 to 2020, for measuring the economy’s default risk.

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The data was mapped against information on Central Banks’ gold stocks obtained from the World Gold Council database. The findings of the study reveal a negative and significant association of sovereign CDS spreads with Central Bank gold holdings of an economy.

Reduce uncertainty

The researchers noted that the likelihood of a credit ratings downgrade decreases with larger gold holdings of Central Banks by reducing future uncertainty and reassuring confidence in investors and policy makers.

It investigates the variation in the negative relationship between Central Bank gold reserves and sovereign CDS spreads, specifically, during periods of high volatility in global financial markets and country-specific crisis.

This variation is found to be even stronger during periods of high global volatility, as well as country specific debt and inflation crisis. There has been a general increase in the RBI’s stock of gold reserves since 2018.

Aid diversification

Sanket Mohapatra, IIM-A professor, said, “Central Bank gold reserves have been known to aid in diversification of overall international reserves and may boost returns during extremely low or negative international interest rates.”

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Central Bank gold reserves can also have a positive impact on sovereign creditworthiness, particularly during times of financial market volatility and crisis episodes.

A more active involvement of gold can diversify India’s overall international reserves portfolio. He is optimistic about gold playing the role of a stabilising agent in India’s external position.

Notably, as per the World Gold Council data for Q2 of 2021, India added over 42 tonnes of gold in the past one year to its reserves to touch 703.71 tonnes. India’s Gold reserves have increased by 13 per cent or about 85.5 tonnes since Q2 of 2019.