The Sovereign Gold Bond (SGB) scheme was introduced in India by the government in November 2015. This initiative was part of a broader strategy to reduce the demand for physical gold and curb gold imports, which significantly impact the country’s current account deficit. The SGBs offer investors a secure way to invest in gold without the need to hold physical gold, providing both capital appreciation and a fixed annual interest.
Why Government May Discontinue Sovereign Gold Bond Scheme??
- Sovereign Gold Bond Scheme may scale back or even discontinued by the government which they consider as expensive. This move coincides with the Union Budget cutting custom duties on gold and silver to 6 percent from 15 percent and Platinum custom duty is reduced to 6.4%.
- The reduction in custom duty is expected to dampen demand for Sovereign Gold Bond Scheme. Following the tax cut Sovereign Gold Bond Scheme prices on the National Stock Exchange fell by 2-5 Percent. In fact government has already reduced its target of 30% to 40% to introduce SGB Scheme in the year 2024-2025
- The first Tranche of SGB issued on November 30, 2015 reached its final redemption in November 2023. Investors who participated in the SGB Scheme 2016-17 series 1 issued in August 2016 are nearing their final redemption which is set for the first week of August 2024. The original issue price of Sovereign Gold Bond 2016-17 series 1 was Rs 3,119 with an annual interest rate of 2.5%.
- The redemption price of SGB is calculated using the average closing price of 999 purity gold as published by the Indian bullion and Jewellers Association Ltd for three business days preceding the redemption date.
- Investors pay issue price and the bonds get redeemed on maturity. The current interest rate for SGB is 2.5% per annum. The interest rate is fixed for the entire tenure of the bond, which is eight years. The gold bond interest is credited to the investors account in every six months.
- The government has reduced its target for issuing gold bonds in the financial year 2024-25 by 38% compared to the previous interim budget goal. The revised target stands at Rs 18500 crore down from 29,638 crore estimated in the interim budget and Rs 26852 crore (revised) in 2023-24. There hasn’t been an issue for Sovereign Gold Bond since February this year.
- The decision followed a reassessment of various factors including investor demand other investment products and uncertainties around the global economy as the situation has changed since the interim budget in February. By announcing a cut in gold customs duty in the Union Budget 2024, gold prices tumbled over 5% wiping off over Rs 10.7 lakh crore in value in a single day. When compared to the equity markets this move caused the sixth largest wealth erosion recorded so far. More importantly the wealth destruction is likely to have hit far households than the damage caused by the big falls in equities because the number of households owning gold is far higher in comparison.
- The fall in gold prices primarily impacts Indian households which combined own some of the largest reserves of gold across the world. Currently Indian Households own approximately around 11% of the entire world’s gold. This is more than the large developed nations like USA, Germany, Switzerland and the IMF combined.
Why did gold prices fall on Budget Day?
- Since the year began, gold prices had been on a tearaway rally, jumping 14.7 percent and outperforming the Sensex, which has risen around 11 percent during the same time. Thus far in July, MCX gold has dropped by nearly 5.2 percent.
- However, during the Budget, the Finance Minister announced a reduction on Basic Custom Duty on gold and silver from 10 percent to 6 percent and Agriculture Infrastructure & Development Cess (AIDC) from 5 percent to 1 percent. It will effectively reduce the overall taxes on gold from around 18.5 percent (including GST) to 9 percent. Gold traders were not happy with the move to reduce the value of the precious metal and began selling off their holdings, booking profits.
- Gold financiers were also none too pleased with the move, as it reduces the value of gold and will significantly reduce their loan-to-value (LTV) ratios, making them less financially secure. A lower LTV ratio means that the value of the gold used to secure loans is less compared to the total loans issued, thus reducing the companies’ margin of safety.
- Even Indian households and temples, which combined own over 30,000 tonnes of gold, saw the value of their holdings sharply. However, the beneficiaries that will benefit from the move are organised jewellery players. The reduction in duty has been a long-standing demand of traders, as it will slow down smuggling as well. For the exchequer, lower smuggling is always positive. How this will impact the Centre’s revenues going ahead remains to be seen, as India is a net importer of gold.
Impact of Sovereign Gold Bond Discontinuation
The discontinuation of Sovereign Gold Bonds (SGBs) in India could have several implications, both for investors and the broader economy. Here are some potential impacts:
- SGBs provide a secure and government-backed investment opportunity, combining the potential for gold price appreciation with fixed interest returns. Discontinuation removes this low-risk investment avenue.
- Gold is often used to diversify investment portfolios. Without SGBs, investors might have to look for alternative gold investment options like physical gold, gold ETFs, or digital gold, which may carry higher costs and risks.
- SGBs offer an annual interest of 2.5% on the initial investment. Discontinuation would mean loss of this regular income for current and prospective investors.
- SGBs help reduce the demand for physical gold, thus helping to control gold imports. Discontinuation might lead to an increase in physical gold imports, affecting the current account deficit (CAD).
- An increase in physical gold imports could widen the CAD, affecting the country’s balance of payments. SGBs can be part of broader monetary policy tools to manage liquidity in the economy. Their discontinuation could necessitate alternative measures to achieve similar economic outcomes.
- The discontinuation might affect market sentiment, particularly if investors view it as a lack of government support for gold investments. This could influence investment behavior and confidence in government-backed securities.
- Investors might shift to other government-backed securities like Public Provident Fund (PPF), National Savings Certificates (NSC), or other bonds.
- Investors looking to maintain exposure to gold might increase their investments in gold ETFs and digital gold platforms.
- The government might introduce or promote alternative schemes to encourage gold savings without increasing physical gold imports.
The actual impact would depend on various factors including the reasons behind the discontinuation, the availability of alternative investment products, and the overall economic environment at the time of the policy change.
