Sovereign Gold Bonds: A Comprehensive Guide for Demystifying India's Gold Investment Option

The ‘value’ of gold is accepted globally. In ancient times, the intrinsic appeal of gold itself had that universal appeal to humans. Eventually, it became a measurable unit of money. Gold’s scarcity, malleability and purity, made it a natural medium of trade. It gave the world the concept of money. Gradually, currency kept evolving, in various tangible forms, now even in an intangible form! Still, did gold lose its value? No, the metal is more popular and coveted than ever! Just no more as a currency but as a strong asset class, with durability and aesthetics appealing to the masses and governments.

India: The largest consumer of gold

In India, gold is perceived as a symbol of purity, prosperity and power. Over the ages, gold has enjoyed a prestigious position in the minds and culture of our land. We have the world’s second-largest market of gold jewellery after China. India is the largest importer of gold in the world, which mainly caters to the demand of the jewellery industry. In volume terms, the country imports 800-900 tonnes of gold annually. Apart from Crude petroleum, gold is the second highest commodity imported by our government.

The heavy import of gold has had a massive impact on the fiscal deficit. The depreciating value of currency, GDP,  and increase in outflows of foreign currency have adversely affected the economy. The Government attempts to curb the demand for gold, by levying higher duties. Last year, the Centre hiked gold import duty to 15% from 10.75% to check the current account deficit (CAD). Gold imports have seen a dip, as we see in the table above on account of higher import taxes and global economic uncertainties.

Introduction of Sovereign Gold Bonds (SGB):

In their continuous battle to fight the demand for gold, the GOI introduced Sovereign Gold Bonds. This was an attempt to deter consumers from investing in physical gold, but providing the same benefits in the packaging of a financial security.

Via a Gazette notification on 30th October 2015, under the Government Monetization Scheme, GOI issued the first-ever Sovereign Gold Bonds. The issue price for the first-ever tranche of Gold Bonds was Rs. 2,684/gm.

Sovereign Gold Bonds and their working mechanism:

SGBs are government securities denominated in grams of gold. They provide an alternative for holding physical gold. Investors have to pay the issue price in cash and the bonds will be redeemed in cash on maturity. The Bond is issued by the Reserve Bank on behalf of the Government of India.  Eligible investors include individuals, HUFs, trusts, universities and charitable institutions. The customers will be issued a Certificate of Holding on the date of issuance of the SGB. Certificate of Holding can be collected from the issuing banks/SHCIL offices/Post Offices/Designated stock exchanges/agents or obtained directly from RBI by email. Investors can choose between Depository Mode and Physical mode. In the case of Depository Mode, RBI will credit the Gold Bonds to the Investor’s demat account. In the case of Physical Mode, RBI will issue a physical Gold Bond Certificate to the investors. To encourage digital purchase, there is a Rs.50/gm discount available on scheduled commercial banks’ websites, for investors who apply online and pay via digital mode.

The Bonds bear interest at the rate of 2.50 per cent (fixed rate) per annum on the amount of initial investment. Interest will be credited semi-annually to the bank account of the investor and the last interest will be payable on maturity along with the principal. The maturity value of Gold Bonds shall be a simple average of the closing price of gold of 999 purity, published by the India Bullion and Jewellers Association Limited, for the last 3 business days of the week preceding the maturity period.

An individual/HUF can invest from 1 gm of gold up to a maximum of 4 kgs in a year. Trusts and corporations can hold up to 20 kgs of gold in a fiscal year.

The tenor of the bond is 8 years, with a lock-in period of 5 years. Early encashment/redemption of the bond is allowed after the fifth year from the date of issue on coupon payment dates. The RBI typically offers redemption windows every 6 months after completion of the 5-year lock-in that can be utilized for completing the premature encashment. The bond will be tradable on Exchanges if held in demat form. It can also be transferred to any other eligible investor with the provisions of the Government Securities Act 2006 and the Government Securities Regulations 2007 before maturity by execution of an instrument of transfer which is available with the issuing agents.

Taxation: The coupon interest of 2.5%, is taxable in the hands of the investor as per tax slabs. No TDS is levied on any interest payments. The capital gain arising on redemption to an individual, if any, is fully tax-exempt. If SGB are transferred, indexation benefit is provided on long-term capital gains. Also unlike physical gold, investor is not subjected to 3% GST.

Reasons to invest in SGBs:

1. Capital Appreciation: As gold prices increase, the price of SGBs reflects the same. If held up to maturity, the capital gain will be equal to the gold rate increase in the 8-year tenor. If transferred, via demat, the prices will be as per demand supply on the exchange. An investor can make the same gains as holding physical gold, without the hassle of any storage cost or GST.
2. Regular Income: The semi-annual payment of 2.5% is declared by the RBI during the issue. Irrespective of market performance, an investor is assured of this return.
3. Hedge against Inflation: Usually when inflation increases, currency depreciates. The gold prices usually react inversely. An investor can be confident in beating increasing inflation, with the rise in gold rates.
4. Tax benefits: SGBs are one of the few securities available that offer a complete exemption from capital gain on redemption. Only the coupon interest rate is subjected to tax. TDS is not levied on the pay-outs. An investor doesn’t have to incur 3% GST like in the case of the purchase of physical gold.
5. Sovereign Guarantee: The bonds are backed by RBI, and the risk of issuer default is non-existent.
6. Diverse Portfolio: An investor can reduce his risk with diversity in his portfolio. Gold is usually deemed to have an inverse relationship with the Equity indices. The investor can mitigate his risk, by increasing the categories of financial securities.
7. Digital Convenience: The investor can manage and monitor his funds invested in SGB digitally, making it a very smooth process for the user. He doesn’t have to stress about the safety and storage aspects of traditional gold. The demat option and online portals only help save time and effort for the end user.

Also Read: Unlocking the Secrets of Sovereign Gold Bonds

How have gold and gold bonds fared since the issuance of SGBs

Gold rates since 2015 have given an absolute return of 135%.

If an investor had invested in physical gold, he would have earned 135% absolute return but would be subjected to 20% long-term capital gain tax.

If an investor had invested in the first tranche of SGBs, in Nov 2015, he would have received 2.5% interest every year. Moreover, he will be able to redeem his gold bonds, in November 2023 at the market price, without any capital gain tax. Assuming gold price remains at Rs.6204/gm he will reap 135% absolute return, without any taxation on his capital gain. The return earned by an SGB investor is significantly higher compared to an investor in tangible gold.

Comparison of Different Gold Investing Options

Traditionally investors since ages prefer investing in physical gold. As time progressed, digital gold, gold Exchange Traded Funds (ETFs), gold mutual funds and Sovereign Gold Bonds evolved.

• Physical Gold: This remains the most popular option in our country. Around 75% of households in India own cumulatively approximately 25000 tonnes of gold. The most preferred method of buying gold is cash(almost 90%) and its major purpose is jewellery. Physical gold is not still perceived as an investment, its role extends to culture, worship and fashion. Demand for gold is majorly for the jewellery industry and the other 3 options cannot substitute for the same. They can majorly only attract investors who wish to invest in gold and not consumers who want to enjoy gold!
• Digital Gold: There are various apps offering the purchase of digital gold. They also come with the option to convert to physical gold. It is an emerging option, with many players, as the paradigm shift is slowly happening. Some companies are allowed to invest as low as even Re.1 in digital gold.
• Mutual Fund and Gold ETFs: Gold Exchange Traded Funds are traded on stock exchanges just like shares and primarily feature Physical Gold and stocks of gold mining/refining as the primary underlying assets. A Demat Account is mandatory for investing in Gold ETFs. Gold Mutual Funds are managed by various AMCs with a fund structure, primarily investing in Gold ETFs. The key differentiator between ETFs and SGBs will be the interest pay-outs and tax benefits enjoyed by the later. The benefit of investing in SCBs is clearly more beneficial for the consumer.

Way Forward:

The Centre, so far, through RBI has issued 62 tranches and raised around Rs 43,000 crore. The last issue was in March 2023 at Rs.5,611/gm. There were 4 issues of SGB in 2022-23 and 12 issues in 2021-22. The SGBs are being perceived as secured and promising, they have had successful issues and massive response from the investor community.

As more and more investors become aware of gold bonds and their unique tax benefits, we will certainly see a change in mindset of people and hopefully a migration from the tangible gold market. Substituting jewellery is not possible with intangible gold securities but certainly it attracts a consumer of physical gold who desires capital appreciation. The reduction in demand of physical gold can help our government, by reducing the fiscal deficit and protecting our dollar proceeds. We may even see corporates entering into this domain, of issuing gold bonds apart from gold ETFs and MFs.

Traditionally and culturally, gold is India’s most coveted metal. An Indian psyche will surely accept its digital variants and derivatives and continue being bullish on this quintessential commodity. With the RBI backing the same in form of SGBs, we have no second thoughts on its efficiency. SGBs will attract investors to digitise gold and still enjoy its returns.

(Source: RBI, BondsIndia Research)