Sovereign Gold Bonds
Sovereign Gold Bonds (SGBs) are a kind of Government bonds that are issued (by the RBI on behalf of the Government) on payment of rupees but denominated in grams of gold. The value of these bonds is tied to the value of gold. On redemption, the investor gets interest income and the prevailing price of gold.
These bonds are thus, different from usual Government securities (G-secs) as the redemption value at the time of maturity is not a fixed sum, but linked to the price of an underlying commodity called gold.
For example, if an investor invests in a 10 gram SGB, at the price of say Rs 2,500 per gram, then he is entitled to an yearly interest income at a certain ‘x’ percentage, plus on maturity, he will get the then prevailing price of gold (which may not necessarily be Rs 2,500 per gram).
Like G-secs, SGBs are also backed by a sovereign guarantee.
The introduction of the Sovereign Gold Bonds was announced in the Union Budget 2015-16. Accordingly, the detailed guidelines of the scheme were notified by the Government on 30 October, 2015 and the scheme was formally launched by the Hon’ble Prime Minister of India along with the other two gold schemes – Gold Coin & Gold Monetization Scheme - on 5 November 2015. The first tranche of issuance of the SGBs was accordingly opened from 5 November 2015 to 20 November 2015. Bombay Stock Exchange and the National Stock Exchange started trading in sovereign gold bonds from June 2016 onwards, very much similar to the way a share is traded.
Gold Monetization Scheme focuses on those individuals who have gold available with them and intend to encash it for realizing its monetary value. On the other hand, sovereign gold bonds scheme targets those individuals who intend to purchase gold, for investment purpose.
Advantages and disadvantages
To the investor
The advantages to the investor in investing in SGB instead of gold are the following:
- Interest earnings on an otherwise dead asset.
- Ease of storage and handling gold, while preserving its advantage of earnings in terms of appreciation of its prices in future.
- An alternate instrument for investment.
The only possible disadvantage to the investor is that, while in the event of appreciation of the price of gold, the investor gains, however, in the unlikely event of a fall in gold prices, the loss too will be borne by the investor.
To the Economy
The advantages to the Government and the economy are the following:
- Reduction in the cost of Government’s borrowings- the current borrowing cost from the domestic market is around 7-8 per cent. Thus, an interest payment below this level is an yearly saving for the Government on account of its borrowing cost. This difference can be used by the Government to cover the appreciation of gold prices payable to the investors at the time of redemption.
- A decrease in the price of the gold will be a gain for the Government.
- It will reduce the demand for physical gold to some extent and thus helps in reducing the annual demand for import of gold.
The possible disadvantage to the Government will be in the unlikely event of a substantial increase in gold prices. For this, the scheme proposes the creation of a Gold Reserve Fund which will absorb the price fluctuations and the fund will be continuously monitored for sustainability. Further, the issuance of the SGBs will be in tranches to enable the Government to maintain its issuance within its yearly borrowing limits.
- The Bonds are denominated in units of one gram of gold and multiples thereof. Minimum investment in the Bonds is 2 grams with a maximum subscription of 500 grams per person per fiscal year (April – March). In case of joint holding, the limit applies to the first applicant only.
- Price of the Bonds is fixed in Indian Rupees on the basis of the previous week’s (Monday – Friday) simple average closing price for gold of 999 purity, published by the India Bullion and Jewellers Association Ltd. (IBJA).
- The Bonds will bear interest at the rate of 2.75 per cent (fixed rate) per annum on the amount of initial investment (for the FY 2015-16). Interest will be paid in half-yearly rests and the last interest will be payable on maturity along with the principal. Interest on the Bonds will be taxable as per the provisions of the Income-tax Act, 1961. Later series bonds (series IV) bore a fixed interest rate of 2.5%.
- The Bonds will be repayable on the expiration of eight years from the date of issue. Pre-mature redemption of the Bond is allowed from fifth year of the date of issue on the interest payment dates.
- The redemption price will be fixed in Indian Rupees on the basis of the previous week’s (Monday – Friday) simple average closing price for gold of 999 purity, published by IBJA.
- The Bonds can be used as collateral for loans. The Loan to Value ratio will be as applicable to ordinary gold loan mandated by the RBI from time to time. The lien on the Bonds shall be marked in the depository by the authorized banks.
- The investment in the Bonds will be eligible for Statutory Liquidity Ratio (SLR) compliance by banks.
- Sovereign Gold Bonds has been made available for subscription at the branches of scheduled commercial banks and designated post offices through RBI’s e-kuber system – its core banking solution.
- The Know Your Client (KYC) norms on SGBs will be the same as that for gold. Further, this is available for sale only to resident Indian entities including individuals, Hindu Undivided Families (HUFs), trusts, Universities, charitable institutions etc.
- In future, gold bonds may be made tradable (from a date to be notified by RBI) and to facilitate the same, the investor will have the option to keep the gold bond in demat form.
KUB Rao Committee Report
As per the KUB Rao Committee Report of 2013 , “large and sustained gold imports are a strain on the external sector’s stability. Given the precarious global economic situation and its impact on the Indian exports, there is a clear need to reduce the Current Account Deficit (CAD) considerably. Due to falling gold re-exports, India’s trade deficit as well as CAD as ratio to GDP worsened by 0.3 percentage points in 2011-12. Viewed from the fact that India has a large appetite for gold, it is desirable that the economy needs to moderate the demand for gold imports to bring down the CAD to a more sustainable level.”The Report also observed that ‘There is a need to consider introducing new gold-backed financial products to reduce the demand for physical gold.’
Rationale for a Gold Bond
India is one of the largest consumers of gold in the world and imports as much as 800-1000 tonnes of gold each year. It is estimated that roughly around 30 per cent of the import of gold in the country, on a yearly basis, is to meet the demand for gold for purely investment purpose. In this context the Finance Minister in the Union Budget 2015-16 Speech, made the following announcement:
Para 63. “I propose to: …
(ii) ...develop an alternate financial asset, a Sovereign Gold Bond, as an alternative to purchasing metal gold. The Bonds will carry a fixed rate of interest, and also be redeemable in cash in terms of the face value of the gold, at the time of redemption by the holder of the Bond.
The demand for gold for investment purpose is due to the returns and ease that the metal provides vis-à-vis other investment instruments. Given these benefits, the demand for gold for ‘investment purpose’ can be shifted away from physical gold, only if an alternate financial instrument for investment, which is linked to price movements of gold is made available. The newly introduced Sovereign Gold Bonds scheme aims at achieving this objective.
Earlier Gold Bond Schemes
The Gold Bond schemes that have been launched by the Government of India, so far, have been based on the idea of accepting a deposit of gold from the customers and providing them with certificates (or bonds) for a fixed maturity and interest payment. These included the 15-year Gold Bonds at 6 1/2 per cent (November 1962), 7 per cent Gold Bond 1980 Scheme (March 1965), National Defence Gold Bonds 1980 (1965), Gold Bond Scheme (1993).The present scheme is different from the earlier schemes since it involves the issuance of a gold bond on payment of rupees instead of taking a deposit of gold.
- Gazette Notification dated 30 October 2015 on Sovereign Gold Bonds
- RBI’s operational Guidelines for implementing agencies dated 4 November 2015
- Summary features of Gold Bond Scheme, RBI dated 30 October 2015