Higher the central bank gold reserves lower the sovereign credit risk

Higher the central bank gold reserves lower the sovereign credit risk

Subject – Economy

Context – Higher the central bank gold reserves, lower the sovereign credit risk: IIM-A centre’s study

Concept –

• Gold reserves of Central Banks can reduce the sovereign credit risk of countries, according to 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 risks, gold holdings of a 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.
• The findings of this cross-country study suggest that higher Central Bank gold reserves can help in stemming a deterioration and provide support to the credit ratings of countries such as India.
• The researchers considered five-year sovereign credit default swap (CDS) spreads for 48 advanced and emerging countries over a 20-year period, from 2000 to 2020, for measuring the economy’s default risk.
• The researchers noted that the likelihood of a credit rating 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.
• 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.
• Central Bank gold reserves can also have a positive impact on sovereign creditworthiness, particularly during times of financial market volatility and crisis episodes.