Gold price correction to boost financial system: RBI paper

A Reserve Bank of India working paper on gold prices has said that any correction would cause stabilising impact on the indicators of the Indian financial system

A Reserve Bank of India working paper on gold prices has said that any correction would cause stabilising impact on the indicators of the Indian financial system.

Even empirical analysis provides credence to the view that any deep correction in gold prices would not have any adverse implications for financial stability. In fact the empirical results of this study provide support to a contrarian view that any correction in gold prices would cause stabilising impact on the financial indicators of the Indian financial system, the report authored by Rabi N Mishra and G Jagan Mohan of the RBIs Financial Stability Unit (FSU) said.

Viewed from this perspective,the likely financial stability implications of a correction in gold prices would be less severe on the financial system. Holding of gold among financial intermediaries is currently low though rising. It is bought mostly by the household sector as an alternative savings avenue and to meet social/cultural needs and not for speculative purposes, the report said.

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According to the RBI study,the developments in gold market in 2011-12 are taking place against the backdrop of global and economic uncertainties caused by the downgrading of sovereign debts and the debt crisis in many of the European countries.

The scenario that would require gold to fall sharply would entail a turnaround in the global economy,subsiding of geopolitical tensions and a reversal of monetary accommodation. In that scenario,equity and other risky assets ought to recover as investors move money away from safe haven assets like gold and US treasuries.

The implications of a deep correction in gold prices on financial instability depends on: whether gold is in a bubble state or not and the nature and significance of gold in the overall financial architecture. Gold,unlike a financial asset,is not associated with cash inflows.

This makes it somewhat difficult to judge on a historical basis and predict the nature of correction in gold prices in the immediate future,the RBI said.

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