On June 17, 2021, the Bank of Ghana launched a historic domestic gold purchasing programme to augment the country’s foreign exchange reserves. The ambitious programme, which aims to double the country’s existing 8.77 tonnes of gold reserve over the next 5 years, was in furtherance to a projection the Central Bank made in its February 2021 MPC press conference.
The decision by the Bank of Ghana (BoG) follows similar shifts by Central Banks globally as they face a period of currency and trade uncertainty and look to diversifying their reserves/investments so as to mitigate some of these identified risks. In March this year, the Central Bank of Hungary purchased 63tonnes of gold, while Thailand purchased about 90 tonnes between April and May.
Brazil has reportedly added about 41 tonnes of gold to its reserves over the past couple of months. India, Kazakhstan and Uzbekistan, who appear to be regular buyers, have all added to their reserves already this year. Since the global financial crisis in 2008, central banks have been net buyers of gold.
The pandemic has significantly increased economic uncertainties by triggering new sources and amplifying existing risks and although the rollout of vaccines offered some hope that the worst is over, the policy response by governments will have inadvertent consequences and generate strategic structural movement in assets.
The policy responses have led central banks turning to gold; a trend that is set to continue in 2021. A Central Bank Gold Reserves (CBGR) survey conducted by the World Gold Council (WGC) highlights several notable shifts in central banks’ attitude toward gold. WGC projects 21% of global central banks to purchase gold this year.
According to IMF’s data on proportion of central banks’ reserves held in gold at the end of March 2021, Ghana ranks 73rd in the world and 8th in Africa after Algeria, South Africa, Libya, Morocco, Nigeria and Mauritius with gold accounting for 6.6% of total reserves held by the Bank of Ghana. Gold holdings remain low not only in Ghana, but across emerging and developing markets, providing ample room for increase.
International reserves have evolved over time, largely driven by significant economic events that required policy shifts. Prior to the 20th century, gold had been the main reserve ‘currency’. While countries began printing paper currency backed by gold and other instruments at the turn of the 20th century, huge military expenditure incurred by many countries during the second world war meant that gold-backed paper currency was no longer sustainable, leading to the formation of the Bretton Woods institutions in 1944 to, among other things, maintain exchange rate stability and harmonize members’ monetary policies. Although paper currency – and cryptocurrency more recently – has been at the forefront since then, the value of gold in international trade and reserve management cannot be overemphasized. Gold has become a foundation of managing reserves in the contemporary world.
Gold as an asset
Gold is the third most widely held reserve ‘currency’ after the US dollar and euro. This highlights the preference for gold as a reserve asset among central banks. Not only does gold satisfy the three core principles of reserve management – safety, liquidity and return – it also carries no credit risk and confers zero liability on any entity.
Gold, also referred to as the yellow metal, is generally accepted to have an intrinsic value and tends to be the go-to asset in times of exchange volatility and uncertainty. Gold has a safe appeal to investors as it is free from political risk and not directly linked to any government’s economic policies. With no credit risk and a good hedge against systemic risk, currency depreciation and inflation, gold remains a strategic asset and particularly enticing currently, as economies are fraught with increasing political uncertainty, threat of debt monetization and currency hostility.
Gold is also a sought-after asset due to its liquidity; it can easily be traded for cash and other near cash assets. The yellow metal is globally accepted and has a deep and highly liquid market, comparable to major sovereign fixed income markets. Even more, there exists a vibrant gold swap market to support central bank actions.
Ever since gold was freely traded at the end of Bretton Woods era in 1971, the value of gold has edged up by an average of 10% per year. Accordingly, in the long term, yield on gold is comparable to equity and higher than bonds and other commodities. Central banks, while keeping gold in their portfolio of reserves, can also manage the asset to create extra returns.
Why a Central Bank may prefer gold as reserve asset
There are observed attitudinal patterns among central banks toward holding gold in recent times, particularly in frontier and emerging economies. A Central Bank’s desire to push more into gold reserves can be attributed to combination of factors.
- The Central Bank can achieve a more diversified reserve portfolio through increasing its gold holding. Gold is noted to possess good diversification characteristics in a currency portfolio because its returns have a low correlation with other assets that central banks usually hold. Gold’s worth is dependent on world supply and demand while currencies and sovereign securities are determined by government actions and varied monetary policies. Therefore, gold price behaves in a dissimilar way to the prices of currencies or the exchange rates between currencies.
- Current economic uncertainties fuelled by the pandemic highlight a need for stability and public confidence. The extent of quantitative easing, debt accumulation, stimulus packages and fresh waves of COVID-19 raises the fear of likely inflationary pressures and a more turbulent path for economic recovery. Gold’s reputation as a safe-haven, an inflation hedge and its credibility as a long-term store of value come in to play.
- The opportunity cost of holding gold has dropped in the face of a consistently low interest rate regime. This presents gold as an attractive asset, a source of real and long-run income, especially when equated to historic negative-yield levels of sovereign debt instruments of advanced economies.
- Uncertainties in the currency market. Emerging economies anticipate that ongoing structural changes in the international monetary system may either destabilize their local economies or result in negative dollar assets. Holding gold assets will therefore be necessary to safeguard and provide ample cushion for the stability of these economies.
- As a de-dollarization policy, a central bank may venture into gold purchasing programmes to reduce their dependence on the greenback. For emerging and frontier economies like Ghana, the likelihood of dollar flight from the local economy in the event of negative investor sentiment or more favourable conditions in the U.S. should keep central banks thinking on the need to diversify away from the dollar. Countries such as China, Russia and Turkey may de-dollarize due to geo-political tensions with the U.S. Whatever a country’s reason may be, it is becoming apparent that the greenback’s safety may not be fool proof.
- Exchange rate risk management. The Bank of Ghana, like other central banks of emerging economies, believes its proposed local gold acquisition programme is an efficient way of preserving the foreign exchange reserves of the country to supplement traditional ways that Ghana has built reserves over the years. The regulator’s resolve to purchase gold locally with cedi means that the country’s already scarce foreign currency reserves will be preserved, while shoring up gold which can easily be converted to dollar.
- As a socio-political decision, the policy is expected to provide a ready market for local gold production and drive economic development by supporting the livelihoods of artisanal and small-scale miners. The policy should spur a growth of the small-scale mining industry and encourage environmentally responsible mining practices.
Expectation from the Gold Purchasing program
The Central Bank’s gold purchase program is expected to have a positive impact on the economy, albeit not without some challenges.
The local currency is expected to strengthen or, at the very least, preserve its value against the US dollar, euro and other foreign currencies. As with import-driven economies, the Central Bank has the herculean task of building considerable foreign exchange reserve while ensuring the local currency maintains its worth. These must all be achieved within the constraint of meeting investor and business demands for foreign exchange. With this program, the Central Bank will be building reserves directly from cedi. The Central Bank can then enter a gold swap arrangement or sell outright to meet subsequent demand on the dollar. This will come as a huge relief on the local currency.
As intimated earlier, this program is expected to open up the local mining industry and provide artisanal and small-scale an unprecedented opportunity to sell gold directly to a major buyer. The program will spur economic growth along the entire mining value chain including ancillary services, and create employment opportunities. The government will also make a strong case to investors about its sustainable mining industry to bolster prospects of issuing green bonds.
If this program is successful, the government will not have to lure foreign investors with high interest rates to attract investment to shore up reserves. With an already-attractive foreign exchange reserve, the country will likely receive favourable interest rates on subsequent bond issuances, an occurrence which will come as a relief to government in light of a looming debt distress.
These said, it must be noted that holding reserves in gold may be expensive. The cost ranges from vaulting, insurance, shipping and settlement costs, to specialist management. The Central Bank’s approach is to purchase dore gold, which is semi-refined and will come with additional cost in refining to the bullion standard.
For the Central Bank’s local gold purchase programme to succeed, several steps ought to be taken.
To start with, a transparent and robust licensing and supervision administration for market participants, particularly aggregators, devoid of political capture and manipulation should be put in place. Buying programmes at designated locations have to be thorough to eradicate smuggling and other corrupt practices.
Also, players in the local gold industry ecosystem need to be motivated by formalizing their operations and granting them access to efficient and environmentally friendly technologies. In order to enhance the process of formalization, promote issues of safety and encourage benign environmental practices, the Central Bank can encourage large-scale gold producers to collaborate with the small-scale miners.
Finally, the Central Bank must ensure that the prices of gold bought locally reflect international prices to ensure that small scale dealers are not short changed.
About the writers
The writers are financial market dealers working with a multinational bank in Ghana. They have expertise in the currency and securities market, as well as a deep interest in the commodities market, most notably gold, oil and cocoa. They can be reached via the contacts below:
+233 50 140 9759 +233 24 275 7286