Why the RBI’s Strategy to Diversify Forex Reserves is as Good as Gold

Earlier this week, US President Donald Trump fired his latest trade war salvo in announcing his decision to impose a flat 25% tariff on all steel and aluminium imports. Soon after, investors across the globe and central banks were flocking to gold as a safe-haven asset.

On January 10, the yellow metal surged to a record high of Rs 88,500 per 10gm in the national capital, fuelled by fears of a global trade war. In the international market on the same day, the price crossed the $2,900 level for the first time.

Why Gold, Though?

Gold has always been as an important component of central bank reserves due to its safety, liquidity and return characteristics, that is, its ability to hedge against inflation. When global uncertainties rise, the asset serves as a cushion and hedges against risks, especially trade imbalances. The metal retains its value even when currencies fluctuate.

Data from the World Gold Council shows that total demand for gold, including over-the-counter (OTC) investment, rose 1% year-on-year in Q4 of 2024 to reach a new quarterly high and a record annual total of 4,974 tonne (t).

"Central banks continued to hoover up gold at an eye-watering pace—buying exceeded 1,000t for the third year in a row, accelerating sharply in Q4 to 333t," the Council said.

“Central bank demand for gold has been a major factor driving international prices since the Covid-19 period, especially in the past year. Emerging market central banks have been actively diversifying their foreign exchange reserves and this trend is likely to continue,” said Abhishek Upadhyay, economist at ICICI Securities.

Tariffs and India's Stance

According to a market research report by financial services group Nomura, emerging Asian economies including India, have higher relative tariffs on US exports and are thus at risk of higher reciprocal tariffs.

"The US accounts for 18% of India’s total exports [2.2% of gross domestic product as of FY24] and is India’s largest export destination, with India-US trade surplus rising in recent years to a high of $38bn in 2024," the report said. Iron and steel and aluminium account for nearly 5.5% of India’s exports to the US.

"Even if the tariffs apply only to raw metal and not finished products, India’s metal sector could still face indirect challenges as China and South Korea may redirect their excess supply to India, leading to a supply glut and price weakness," says Jateen Trivedi, VP, research analyst, commodity and currency at LKP Securities, a financial and investment solutions firm.

And while there has been no direct confrontation yet between India and US when it comes to trade matters, India has reduced import duties on a number of products, including electronics, textiles and high-end motorcycles in its Union budget, 2025.

According to a Reuters report, India is also considering reviewing import tariffs on over 30 items including luxury cars, solar cells and chemicals.

A Silent Gold Rush

The Reserve Bank of India (RBI) has been steadily accumulating gold since 2017 as part of its reserves management strategy. India's foreign exchange reserves stood at $630.6bn as of January 31 this year, a $1.05bn hike from the week ending in January 24. It was the second increase in forex reserves after they went up by $5.5bn in the week ending January 17, according to The Economic Times. Gold reserves, which went up $1.2bn and settled at $70.89bn in this period, primarily drove this growth.

The RBI’s gold purchases come at a time when India’s overall foreign exchange reserves have declined from $704.885bn on September 27 last year to this year’s January 31 level due to the central bank’s interventions to stabilise the rupee. During the same period, gold reserves increased by $5.1bn.

Dollar is a dominant component of the country's foreign exchange reserves and the central bank also holds reserves in other currencies, apart from gold.

The sale of dollars to defend the rupee had an impact on reserves as foreign currency assets have the highest share in reserves.

Responding to a question by Congress MP Manish Tiwari in Lok Sabha if the shift towards gold was an indication of moving away from the US dollar, Finance Minister Nirmala Sitharaman clarified that the RBI’s gold accumulation is aimed at maintaining a balanced reserve portfolio rather than replacing any international currency.

Tiwari also pointed out that after the US abandoned the gold standard in 1971, the metal lost prominence as a financial asset. However, global central banks have since reversed this trend—raising gold holdings from 6% of total reserves in 2006 to 11% in 2024. Countries like China, India, Poland and Turkey have been particularly aggressive in their gold reserves accumulation, he said.

Sahana Roy Chowdhury, professor of economics at the International Management Institute, Kolkata notes that while many countries boosted their gold holdings after the Russia-Ukraine war broke out, India’s accumulation began earlier, driven mainly by portfolio diversification rather than geopolitical retaliation. “In case of gold revaluation, there will not be gains but it protects against potential losses,” she said.

Abhishek Upadhyay adds that while the RBI has nearly doubled its gold reserves from pre-Covid-19 levels, it is unclear if the central bank is targeting a specific percentage of gold in its reserves.

With Trump’s trade war heating up, gold’s record-breaking rally and central banks globally boosting reserves, it remains to be seen if this heralds a golden era for the precious metal.