India mines just 0.1% of the globally mined gold however it has almost 25% share of the overall global annual demand of the yellow metal. This puts a lot of pressure on country’s current account and foreign exchange reserves. In the annual Union Budget of 2015, with the intent of enabling purchase of gold in electronic form and reducing gold imports, government announced the Sovereign Gold Bond Scheme (SGBS).
Sovereign Gold Bonds(SGBs) are government securities denominated in grams of gold. Investors have to pay the issue price in cash and the bonds are redeemed in cash on maturity basis the then prevailing market price of gold. SGBs offer a much superior alternative to investors looking to take exposure to gold. Under the scheme, not only the risks and costs of storage are eliminated, investors are further promised an assured periodic coupon (presently at 2.5%). To further sweeten the deal for the investors, a complete tax exemption is given on the capital gains arising on redemption of Sovereign Gold Bonds at maturity. While a great investment option for the investors, the scheme exposed the government to price fluctuation risks considering the scheme was neither backed by physical gold nor hedged by the government (also highlighted by Niti Aayog Watal committee). With the recent rally in the yellow metal prices, these risks have come to the fore and this may force the government to go back to the drawing board and revamp the scheme.
So far, almost forty tonnes of gold equivalent securities have been issued by the government under the scheme at various issue price (The tranche wise details are given at the end of the article). Though the tenor of the bond is eight years, early redemption of the bond is allowed after fifth year from the date of issue. Considering that the first tranche of SGBS was issued in November 2015, the securities will be eligible for early redemption by the end of this year. For this tranche even after assuming that there would not be any further increase in the price of gold, the overall annualised costs to government including the periodic coupon payments would work out to be fifteen percent. This would mean that government would be paying a whopping 750 bps over the corresponding tenor normal bond it could have raised in November 2015. The overall costs for the second tranche comes to be even higher, considering the gold price at the time of second issuance was lower than first tranche. This clearly depicts the significant fiscal risks associated with the scheme.
An argument is often made in favour of the scheme that RBI holds gold as part of forex reserves which is much more than the SGBS amount and that serves to hedge the risks of the scheme. But that argument doesn’t hold merit since:
- Firstly, the holding period of gold as part of forex reserves doesn’t necessarily mirror SGBS tenor. For example, let’s say tranche one has hundred crores of redemptions at the end of this year. It doesn’t mean that RBI will liquidate an equivalent amount of gold as the redemptions come. This means that the gold which continues to be with RBI may go down in value as well in future while the Sovereign Gold Bond investors would have booked their gains for which the government would have already made the payouts.
- Secondly, and more importantly, the allocation of Gold as part of Forex reserves is an independent decision that RBI takes to optimise the risk return of the portfolio. Even before the Sovereign Gold Bond Scheme, RBI continued to hold Gold with a view to reap returns from the same. Doing a mental mapping that government gains an equivalent amount from RBI’s gold holdings doesn’t factor in the opportunity costs of the investments. Further, these gains need not be passed to the government automatically as RBI’s dividend distribution is governed by Bimal Jalan Committee Economic Capital framework which doesn’t allow for revaluation gains to be transferred to the government.
- Thirdly, in case let’s say a framework were to be set up under which RBI (or any government entity) would be required to incrementally procure gold equivalent to the amount raised under SGBS. This would beg the question on the merits of the scheme since essentially gold imports would still be there, just that the demand would have been shifted to institutions from retail.
Considering the fiscal risks associated , the scheme in present form doesn’t seem a scalable solution to Financialisation of Gold and commands a review.
Issuance Details of Sovereign Gold Bond Scheme
|Series||Issue price/unit||Number of units (in grams)|
|2016-17 Series I||3119||29,53,025|
|2016-17 Series II||3150||26,15,800|
|2016-17 Series III||3007||35,98,055|
|2016-17 Series IV||2943||22,20,885|
|2017-18 Series I||2951||20,27,695|
|2017-18 Series II||2830||23,49,953|
|2017-18 Series III||2956||2,64,815|
|2017-18 Series IV||2987||3,78,945|
|2017-18 Series V||2971||1,74,024|
|2017-18 Series VI||2945||1,53,356|
|2017-18 Series VII||2934||1,75,121|
|2017-18 Series VIII||2961||1,35,666|
|2017-18 Series IX||2964||1,05,512|
|2017-18 Series X||2961||1,07,380|
|2017-18 Series XI||2952||81,614|
|2017-18 Series XII||2890||1,11,218|
|2017-18 Series XIII||2866||1,31,958|
|2017-18 Series XIV||2881||3,27,434|
|2018-19 Series I||3114||6,50,337|
|2018-19 Series II||3146||3,12,258|
|2018-19 Series III||3183||4,09,398|
|2018-19 Series IV||3119||2,07,886|
|2018-19 Series V||3214||2,43,606|
|2018-19 Series VI||3326||2,07,388|
|2019-20 Series I||3196||4,59,789|
|2019-20 Series II||3443||5,35,947|
|2019-20 Series III||3499||10,24,837|
|2019-20 Series IV||3890||6,27,892|
|2019-20 Series V||3788||4,55,776|
|2019-20 Series VI||3835||6,93,210|
|2019-20 Series VII||3795||6,48,304|
|2019-20 Series VIII||4016||5,22,119|
|2019-20 Series IX||4070||4,05,957|
|2019-20 Series X||4260||7,57,338|
|2020-21, Series I||4639||17,72,874|
|2020-21, Series II||4590||25,44,294|
|2020-21, Series III||4677||23,88,328|