Why Gold Bond Scheme 4th tranche may not be successful

Government officials are increasingly sounding like brokers. On Saturday, Economic Affairs Secretary Shaktikanta Das tweeted “Next tranche of Gold Bond Scheme to open from July 18-22. Excellent opportunity to invest and benefit from gold price appreciation.” Das was attempting to capitalise on the fact that gold prices had touched a three-year high on the back of Brexit uncertainties.

Das was trying to market the fourth tranche of the Gold Bond Scheme, the first such in the current financial year.

Sovereign gold bonds (SGBs) are government securities denominated in grams of gold and issued by the Reserve Bank of India on behalf of the Government of India. They have been introduced as a substitute for physical gold. In case of SGB, the issue and redemption are both done in cash but linked to the value of gold.

The government managed to raise Rs 1,320 crore in FY16 through three tranches by selling 4,908 kg of gold through SGB to about 4.50 lakh investors. In the fourth tranche the government has made certain changes, learning from its lessons in the first three tranche.

Following are the changes incorporated in the present round of Gold Bonds:

Denomination reduced: The minimum subscription has been reduced from 2 gram to 1 gram with the view to enlarge the subscriber base. Price for gold has been fixed at Rs 3,119 per gram. Maximum subscription ceiling has been retained at 500 gm per person.

Tax Changes: There have been some important changes made in taxation to make the scheme lucrative. Capital gain tax arising on redemption of SGB to an individual has been exempted. Earlier capital gain tax was imposed at the same rate as in the case of physical gold. Further, indexation benefit has been provided to long-term capital gains arising to any person on transfer of bonds.

Holding form: As against the earlier method of holding which was through certificate of holding, government has permitted holding these bonds in dematerialized form.

Receiving offices: Apart from the original receiving offices like scheduled commercial banks, Stock Holding Corporation of India Ltd (SHCIL), designated post offices government has now allowed the two stock exchanges BSE and NSE to function as receiving offices.

Interest payment continues to be at 2.75 per cent per annum on the amount of initial investment. Though the bonds are for a period of eight years, premature redemption has been permitted after the fifth year from the date of issuance of such bonds. Redemption price of the bond was fixed on the basis of the price of gold of 999 purity of previous week published by the India Bullion and Jewellers Association Limited.

Comparing the amount of gold imported, which stands at around 1,000 tonnes annually, gold bonds subscription of 4.908 tonnes is miniscule. Indian’s continue to prefer to buy gold jewellery rather than gold bond. Government has taken into account the poor response and has made changes to offering, but will it be enough to attract investments?

Given the global uncertainty, especially after Brexit, it is a good time to invest in gold. But unlike the precious metal, gold bonds have a lock-in period which prevents an investor from capitalising on the intermittent gain. An eight year lock-in period is a long time in the present scenario. There seems to be little logic in having a long lock-in period on an instrument with such low yields.

Further, the incentive given by government to move from physical gold to paperless gold seems to be too small to attract investment, especially since they are taxable. It is surprising that the government has considered removing capital gains but wants to tax the paltry interest payment.

Even for banks investing in SGB is unattractive. Though government has made investment in SGB eligible for Statutory Liquidity Ratio, it low interest rate given the price risk in gold makes it a non-starter.

Finally, unlike China, Indian demand for gold is largely skewed towards jewellery as compared to bars and coins. Appetite for gold is more out of cultural requirement such as marriages rather than as an investment instrument.

Though government intention of issuing gold bonds is laudable, it will take some time before investors latch on to it.