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Saturday, April 09, 2011

US Dollar, Indian Rupee and Gold

You would have come across an article or two saying everything is wrong with US Dollars, unless you were hiding in a cave.  I am trying to look at what could be wrong, fundamentally.

Indian Rupee
Reserve Bank of India has in circulation Rs.8,420,409,791,000 worth of notes (8.420 trillion or 8.420 Lakh Crores).  There is Rs. 485,772,152,000 (0.485 Trillion or 485 Thousand Crore) worth of gold against it.  That is about 5% of Rupee in circulation is backed by gold and all of the gold is held in India. 
1. It means that about 95% of the currency backing is foreign securities.  So, if you are holding a Rs. 1000 note in your hand - Rs.50 worth of that is in gold and Rs.950 is in foreign securities. 
2. It also means that notes in circulation is about Rs.8,000 per Indian vs. per capita income of about Rs. 44,000.  Considering that Rupee doesn't move much outside the border, it gives you a rough idea of how fast the currency changes hands.

Now let us talk about the 950 of the 1000.  RBI is permitted to hold such securities in the currency of any IMF member country or in securities issued by IMF, World Bank or BIS.  Here's the key condition - the maturity of these cannot be beyond a period of 10 years.  Also, the Gold in the 50 of the 1000 - 85% of that should be held in India.

Now, here's another factoid.  About 60+% of world currency reserves are held in USD.  So if we assume that 2/3rds of the Rupee is USD since it is backed by foreign securities, we have about Rs. 670 of that Rs. 1,000 is USD.  So, when you are holding that Rs.1,000 note, you are actually holding about USD 15 plus about 1/40th of a gram of Gold and the rest in others.  (That should be enough to pause before you spend, to think of what you are exchanging really.)

I admit that the reserves are actively managed by RBI by people who think about this risk and nothing else.  Still, if want to achieve just a 50% cover in Gold, it would mean about 10,000 years of 200 tonne lot of Gold buying or Gold price appreciating that many times.  Both look like wishful thinking.  US Dollar, therefore, is a cause for concern to us even if we are earning and investing in India. So, if USD is worthless,  around 70% of INR is worthless.
(Source for data: Reserve Bank of India)
US Dollars
Compare this scenario against US Dollars (Feb 2011) - 
Currency - 928.7 Billion
Reserve Assets - 134.7 Billion.
Value of reserve Assets hide a very important picture - Gold stock valued at 11 Billion is valued at $42.22 per Troy Ounce.  The value of gold in the market per troy ounce in Feb. was between $1,340 and $1,440.  Revaluing gold would add another 350 Billion to the reserves.   Still we have 485 Billion Vs 929 Billion of currency issued.  To achieve parity, Gold would have to go up double from this (no, I am not making a prediction).
(Source for data: Federal Reserve and Kitco for gold prices)

Look at it this way, every time USD loses value, INR loses about 70% of that in relation.  Now, this is only a comparison of two currencies - against their reserves.  Now, if you take into account interest rate parity adjusted for inflation, growth trajectory of two economies and keeping in mind everything in the forex market moves relative to one another, you can draw your own conclusions on where we are headed.

How is it all relevant?  At the end of the day, when you invest in India everything is denominated in Rupees and settled in Rupees.  This is an attempt to get to the bottom of that Rupee.


Anonymous said...

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Anonymous said...

Very nice indeed I’ll probably download it. Thanks

Anonymous said...

Complex Post. This transmit helped me in my college assignment. Thnaks Alot

Anonymous said...

Thanks for one more greet post. Keep rocking.

Pradeep said...

This is very good.. But this has raised a few more questions in my mind.. If u can really solve them..

Foreign Securities held by India agnaist Rupee (i-e for Rs-950 as u had said How is this Possibele)
How/Why does the govt need to maintain/Buy the foreign Curencies.. Since a fall in Foreign currency can impact the Indian rupee as well.


Nathan said...


You can see the balance sheet here:-
Look for the one after note XI.33 for Issue Department.
The primary reason for holding foreign securities is as backing for currency. Earlier, India was part of the Sterling block and held GBP securities. It changed later to include other governments.
These securities support the promise to pay from the RBI. If you look at the Rupee Notes you have (except One Rupee), you will see that it is a promissory note to a bearer from RBI governor. This promise is backed by the securities. What they mean by the promise is that they will pay the equivalent of 100 Rs. or whatever (note says) in coins issued by Finance department. The Government of India has the sole right to mint coins. (check the website of RBI here:-

Anonymous said...

Awesome! Its genuinely awesome post, I have got much clear idea about from this paragraph.

Anonymous said...
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Anonymous said...

Guya, is it not true that the usa is in trillions of dollars of debt? Why is it then that the RBI keeps a stock of USD? Is it because india believes that the usa will always find a way of paying off debt by printing more dollars and maintaining value of its dollars by forcing the middle east to trade oil in dollar? Is this the reason why usa installed its puppet govt in Iraq and plan to do the same with Syria and Iraq?

Anonymous said...

Money is a non existent theoretical force that has never, does not and will never exist except in theory on computer screens. People die and starve, Because they don't have enough digits on a computer screen. It is incredible and it is extraordinary, and it is grotesque but unfortunately it is true.

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