Govt stares at high payouts as gold prices double over the last year

The first tranche of sovereign gold bonds will complete five years in November

The sharp rise in the prices of gold —which almost doubled over the past one year —has been the only good news for investors at a time when both equities and debt returns have been under pressure. However, the Union government could be starting at significant payouts in the second half of the year, an additional Rs 1,000 crore, if investors rush to redeem their holdings.

In November 2015, the government had launched Sovereign Gold Bonds (SGBs), with much fanfare, to attract money from gold investors. The basic idea was to reduce gold imports as it leads to unproductive foreign exchange outflows.

While these bonds will mature fully in eight years, investors are allowed to redeem after five years on the coupon date. From November 2020, these bonds will become eligible for redemption.

The government launched three issues in FY16. In all these three tranches, it raised Rs 1,321.2 crore by selling 4,835 kg or 4.835 tonnes of gold bonds.

At current prices, the government will have to pay as much as Rs 2,248 crore if all investors decide to redeem their bonds.

The government has already paid interest of Rs 180 crore on them because the bonds came with a promise that it will earn 2.5 per cent interest annually on the initial investment. This does not include one per cent commission paid by the government to market these bonds.

This cost is almost double than the money raised through this investment and stands at 14.4 per cent annually (for price rise and interest payment).

This is significantly higher than the cost at which the government borrows. The ten-year government bond yield has moved between 6.5 and 7.5 per cent in the past year.

In the coming years, the government will have to continue making payouts as these bonds mature. Till April 2020, the government has launched 38 sovereign gold bond issues, totalling 32.75 tonnes worth gold, valued at Rs 10,475 crore. Bhargava Vaidya, chartered accountant and gold expert, said: “The first issue of SGBs will available for resumption as five years are getting over. Except for those who are in urgent need of liquidity, people should hold on to maturity. Since SGBs provide annual interest, tax benefit and transparent pricing, it is the best form of gold investment.”

With the Covid-19 crisis hitting investors badly and creating liquidity crisis for many small businesses and salaried, SGBs could become an important instrument to raise money. In fact, investors can also raise money from banks by using these bonds as collateral.

And while there is an option of selling these in the secondary market at the stock exchanges, it is not deep enough to absorb small purchases and sales. Investors need to be put out big quantities to be able to trade.

Gold prices have seen a sharp jump during the past year. And the Covid-19 crisis has only made investors more risk-averse. The assets under management of gold exchange-traded funds have been rising steadily, both because of inflows and rising gold prices. However, investors have started booking profits in the yellow metal. In March 2020, gold exchange-traded funds saw net outflows of Rs 194 crore.

According to experts, since the government will not be returning the bonds in physical format, the price risk of the yellow metal hasn’t been hedged. SGBs are sold in the denomination of one gram and at the price of gold prevailing at the time of selling bonds. The formula used is the average of three days’ price of 999 gold as announced by the Indian Bullion and 

Jewellers’ Association. Under the scheme, an investor can buy a minimum of one gram the maximum is four kg of gold.

As far as taxation goes, selling these bonds after five years would attract tax at the rate of 20 per cent on capital gains.

However, there will be inflation indexation benefits that would reduce tax liability. The capital gains become completely tax-free after eight years. The interest income, however, is taxed as per the income tax bracket.

The Reserve Bank of India recently announced the calendar for this year’s SGB issues. The first one closed last Friday.

The apex bank plans another four issuances — between May and September.