Dr. Tamal Datta ChaudhuriPrincipal & Professor, Finance and Economics
There is considerable interest both in the press and in political debates in India, about the sharp increase in the rupee price of the US dollar (R/$), the increase in the price of gold and also the increasing deficit in the Current Account Deficit (CAD). As India’s import of crude oil is the largest component of its total import bill, an increase in its price causes the gap in the CAD to widen and raise the demand for dollars. If there is no commensurate increase in the supply of dollars, this causes R/$ to rise. While the source of demand for dollars is imports of goods and services, the source of supply of dollars is both export of goods and services in the current account and also inflow of dollars through the capital account by way of FII net inflows and also Indian companies borrowing from abroad.
Gold on the other hand is a financial asset. In India there is considerable demand for it in the form of jewelry – but the underlying principle is financial security for the girl child. The other major players in the gold market are the central banks of various countries. Whenever there is some economic or political uncertainty in the world market, there is a tendency of gold prices to rise as it is considered to be the safest asset.
In India, in the recent past, crude oil prices have increased due to the Syria war threat. News of easing of bond buy back in the US has seen dollar outflow from India. Domestic political uncertainty coupled with increasing rate of inflation and relatively low rate of economic growth has led to acquisition of gold as a financial asset leading to an increase in its price. An increase in import of gold has contributed to the widening of the CAD.
The movement in prices of gold (red line), price of crude oil (brown line) and the exchange rate (blue line) in India is shown in Figure 1. In time zone A, starting from May 2013, the price of crude oil has increased significantly and so has the R/$. This has led the price of gold also to rise. Relatively speaking, in time zone B, all three have come down. This indicates the co-movement in the three variables.