By
Dr. Tamal Datta Chaudhuri
Principal & 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.
