This article discusses how the INR to USD exchange rate affects gold prices. Tracking gold-price movements in terms of USD and INR is a simple but intuitive way to understand the strength of our economy. Here are some observations from staring at the historical gold price movement in USD and INR. The domestic price of gold, INR, is the equivalent price in USD times the exchange rate.
Gold in INR vs Gold in USD movement from 1978 to 2016
First, let us look at the normalised (all set to 1 at the start) movement of the price of one troy ounce (31.1 gms) of Gold in USD, INR and the exchange rate (per dollar) derived from these prices.
The data is from 2nd Jan 1979. The emergency ended two years ago, and India was trying to strengthen its economy. However, the fiscal deficit and balance of payments were increasing. That is, India was importing more than it was exporting. It had no forex reserves and was on the verge of defaulting on payments. This was at the start of the 90s. The IMF lent India 2 Billion USD with its gold reserve as collateral.
Notice how Gold (USD) kept going down for 20 years while Gold INR kept moving up!! A currency that was becoming weaker by the day is the reason for this.
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Notice how rapidly the exchange rate increased, including some alarming jumps as the economy opened up.
The exchange began to plateau and then decreased for a while (not seen clearly enough above in the log scale). Then, after more than 20 years, Gold-INR began to track Gold-USD.
Notice that the movement in exchange rates after 2000-08 is relatively minimal relative to the period before. The rupee was now stable as the GDP grew, backed by corporate earnings and a strong market bull run.
We have had hiccups with a surge in gold imports and a highly volatile rupee due to a downgrade in India’s sovereign rating to just one rank below ‘junk status’ in early 2013.
One crucial point we should remember is that it is not good news when fixed-income rates increase. It means the creditworthiness of the country has come down! The rupee becomes weaker.
The 5-year rolling returns of Gold-INR and Gold-USD are compared below.
Notice that the extra returns in INR came because of the exchange rate movement. Any marked departure between the two long-term returns could trouble the economy. Since the start of the last decade, gold INR has been reasonably in step with gold USD. This can be seen with ten-year and 15-year rolling returns data.
One of the most dramatic demonstrations of the strength of our currency can be seen if we plot the Gold INR minus Gold USD 15-year returns or the 15-year USD-INR exchange rate.
The 15-year return on the exchange rate plunged from 9-10% to about 2-3% and has marginally increased in the last few years. As our economy grows, we hope it will head lower over time.