Goodbye, Sovereign Gold Bonds!
The government might discontinue Sovereign Gold Bonds (SGB) Scheme, due to its high cost and changing market dynamics, as per reports.
Sovereign Gold Bonds (SGB) scheme, launched in November 2015, might be scaled down or discontinued by the government.
This move comes after Union Finance Minister Nirmala Sitharaman announced a reduction in customs duties on gold and silver to 6 percent from 15%. This might significantly reduce the demand for the SGB. Subsequently, prices of SGBs on the National Stock Exchange declined by 2-5%.
SGB for the first time was issued on November 30, 2015, and the redemption happened in November 2023. Next time, it will be issued in August 2016, and the redemption date is approaching, which is set to be the first week of August 2024.
However, no SGBs have been issued this year by the RBI.
What is the SGB scheme?
The SGB scheme was announced by the government of India in the Union budget 2015-2016. It is designed for resident individuals, Hindu Undivided Families (HUFs), trusts, universities, and charitable institutions to invest in gold via digital format, basically a substitute for physical gold.
These bonds are only issued by the Reserve Bank of India and can be purchased by numerous brokers and agents, including banks, financial institutions, post offices and NSC (National Security Council) agents.
The bonds are issued in units of grams, with a minimum investment of one gram, whereas the maximum limit will be decided by the government and can change from time to time.
SGB bonds have an eight year maturity period, while investors have an option to encash or redemption only after the fifth year from the date of issuing to protect the interests of investors.
Features of SGB scheme
- Fixed interest rate
The bonds can help investors to earn a fixed interest of 2.5% per annum. This interest will be credited to the bank account of the investor semi-annually, and the last interest will be payable on maturity along with the principal amount. It provides a stable income to the investors.
- Collateral for loans
The bonds can be used as collateral for loans, with the loan-to-value (LTV) ratio determined by the Reserve Bank of India for standard gold loans and updated regularly.
- No storage issue
The bonds are in a digital format, so there is no need to worry about storing physical gold which always has a risk of theft or loss.
- Tradability
The SGBs can be traded on stock exchanges within a fortnight of the issuing date. In case, any investor wants to sell their bonds before tenure, he can do so in the secondary market, offering liquidity to the investors.
- Capital Gains Tax Exemption
The interests on SGB bonds are taxable under the Income Act, 1961. However, individuals are exempted from the capital gains tax while redeeming SGBs.
Why did gold prices fall on Budget day?
Since the beginning of this year, gold prices were high by 14.7 percent, even outperforming Sensex by 11 percent rise.
Consequently, MCX (Multi Commodity Exchange of India) has declined 5.2 percent.
The Finance Minister announced a reduction on Basic Customs Duty on gold and silver and AIDC (Agriculture Infrastructure and Development Cess), which reduce the tax on gold.
Neither gold traders nor gold financiers were satisfied with the move, as it diminished the value of gold and affected LTV ratios. Also, Indian families and temples holding nearly 30,000 tons of gold were not happy after observing a significant decline in the value of their gold assets. The beneficiaries from this move are only organized jewelry players.
The question here arises is India is a net importer of gold and what impact will it make on the Centre’s revenue in the upcoming years?
Government’s agenda
The Government has raised approximately ₹72,274 crore via issuance of SGB since its launch in 2015.
Then, why is the government even thinking about the discontinuation of the SGB scheme?
Banking expert V Viswanathan told The Hindu, “The price of gold per gram in 2015, 2016, and 2017 ranged between Rs. 3,100 and Rs. 3,500. Its pre-Budget level was Rs. 7,200 per gram. That means SGBs which are classified as Government Securities and represent borrowings by the government, will cost the exchequer a lot when they are redeemed.”
He further added, “So, in order to cut down the outgo, the government may have reduced the Customs duty on gold. The per gram price of gold (24 carrots) is now down…So, on redemption of SGBs, the government will pay less, if the same trend continues.”
The SGB scheme was introduced to reduce the demand for physical gold and to use a portion of domestic funds for financial savings. Additionally, the demand for physical gold lowered in the country, it affected exports.
A cut in Customs duty will help the government to pay comparatively less amount as redemption price to investors.
The SGB issues to investors 8 years ago have risen almost thrice. If we consider the SGB scheme of 2016-2017 Series-1 which was issued in August 2016 can be redeemed next month, and the government has to pay a lot of money to its investors. However, the issuing amount was Rs. 3,119 per gram with fixed annual interest of 2.75%.
The redemption price could be Rs. 6,800 per gram, which might bring a return of nearly 140% in 8 years investment, helping investors to gain money. At the same time, this amount will be huge for the government.
Impact of Sovereign Gold Bond Discontinuation
The discontinuation of SGBs would impact investors as well as the economy of India at a larger level.
- Loss of income
SGB provides an investor with an annual interest of 2.5% and discontinuation would lead to loss of income.
- Shift to alternatives
Investors might have to look for other options like PPF (Public Provident Funds), NSC (National Savings Certificates) and NPS (National Pension Scheme) etc. to meet their demands.
Also, investors will look for alternatives of gold investments such as physical gold and gold ETFs, which add a burden on the investor due to its cost and risks.
- Loss of trust
The investor sentiments might get hurt towards government backed securities, if the SGB scheme gets discontinued.
- Impact on Current Account Deficit (CAD)
SGB lessened the need for physical gold, which in turn helped in controlling the imports of gold.
However, if the scheme gets discontinued, investors will start investing in physical gold imports which will increase the CAD, affecting India’s balance of payments.
