The week of September 11 saw India’s central bank run the latest issue of the Sovereign Gold Bonds (SGB) scheme, under which the government issues bonds to investors linked to the price of gold. For the government, it’s a way to raise money for its needs, from funding public expenditure to plugging gaping deficits. For investors, it’s an investment option, made attractive in recent years by the solid performance of gold as an asset class. This, however, should not be taken for granted.
The week of September 11 saw India’s central bank run the latest issue of the Sovereign Gold Bonds (SGB) scheme, under which the government issues bonds to investors linked to the price of gold. For the government, it’s a way to raise money for its needs, from funding public expenditure to plugging gaping deficits. For investors, it’s an investment option, made attractive in recent years by the solid performance of gold as an asset class. This, however, should not be taken for granted.
Data on gold prices from the Reserve Bank of India for this century shows that average 5-year returns for gold—the effective lock-in for the SGB scheme—have exceeded 10% in 12 of the 22 financial years, including the latest three financial years. But there are also 10 years during this block when average 5-year returns from gold were in single digits, even negative. In other words, while gold is less volatile than, say, equity, it’s not a failsafe investment option.
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Data on gold prices from the Reserve Bank of India for this century shows that average 5-year returns for gold—the effective lock-in for the SGB scheme—have exceeded 10% in 12 of the 22 financial years, including the latest three financial years. But there are also 10 years during this block when average 5-year returns from gold were in single digits, even negative. In other words, while gold is less volatile than, say, equity, it’s not a failsafe investment option.
In general, interest in asset classes tends to sync with their recent performance. Gold is an upswing. Between May 2019 and August 2020, for example, gold prices rose from ₹3,173 per gram to ₹5,291 per gram—an increase of 66% in 16 months. This was also the time that SGB scheme subscriptions began picking up. August 2020 saw the highest volume of 6,350 kg (each bond is equivalent to one gram of gold) till then. The SGB issue this June topped it with 7,769 kg. That is the tailwind behind the latest SGB issue.
About the Scheme
The first SGB was announced in November 2015. In all, there have been 64 SGB issues, raising a total of about ₹50,000 crore. As of March 2023, the total amount outstanding under the SGB and another on-tap scheme—the gold monetisation scheme—was around ₹58,000 crore. This is yet only a fraction of the government’s immense funding needs. For 2023-24, the projected fiscal deficit is ₹17.9 trillion.
Under the SGB scheme, each bond is equivalent to one gram of gold. It is issued at a price linked to the average daily closing price of gold announced by the India Bullion and Jewellers Association (IBJA) in the days leading up to the issue. The tenure is eight years, though redemption is allowed after year five. Bonds are redeemed at the average prevailing gold price on the redemption date. Further, the government pays 2.5% interest a year. While interest receipts are taxed, capital gains are not.
Low Redemptions
Given the five-year period, redemption under the SGB scheme began in 2021. Redemptions occur at a price announced by the government, which is linked to the average daily price announced by the IBJA in the days leading up to the redemption date. Since 2021, of the 64 tranches of bonds issued so far, 22 have been offered for redemption.
The premium for these issues—or the capital gain over a 5-year period—is between 47% and 94% over the respective issue price. In spite of this return, the bulk of bonds have not been redeemed by investors. As of June 2023, just 6% of the bonds eligible for redemption have been handed back to the government. It may partly reflect the complicated redemption process, which involves submitting requests for premature redemption at least 10 days before the redemption date, along with identity documents.
Good Returns
The low redemption also reflects the recent strong performance of gold as an asset class. The total return on the bonds comprises interest receipts, and capital gains if the redemption price is higher than the issue price. In that sense, the ‘bond’ has an equity component, which involves a bet that gold prices will be significantly higher on redemption than the issue price.
For the 22 SGB issues where redemption has begun, the average annual pre-tax return on the bonds after five years has ranged between 10% and 16%, depending on the tranche and the maturity date. While these returns are well in excess of what bank deposits offer, it is only in the seven most-recent tranches that returns have exceeded the total return on the NSE Nifty 50 share index over the same period. . While data on collections from the latest issue was not available, returns from gold should not be taken for granted.
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