MUMBAI: In a surprise move, Finance Minister Nirmala Sitharaman slashed the import duty on gold from 15% to 6% in the Budget. On the face of it, the move elated gold buyers as it lowered gold prices in the domestic market, but a section of people – those who parked their hard-earned money in the sovereign gold bonds (SGBs) – realised the decision could shave off a few percentage points from their gains.
However, the fear turned out to be untrue. After the knee-jerk price correction of around 7% after the Budget announcement on July 23 and a cumulative fall of R630/g in the week afterwards, gold prices have already moved up about around 2% as international prices rose and closed at R6,390 on August 3. The all-time high domestic price was R7,500/g in April this year.
The pleasant surprise, though, for the investor was yet to come. Despite the 5% correction in gold prices, the RBI has fixed R6,938 as the redemption price for the August 5, 2016 bonds, resulting in a windfall of as much as 122% over the buy price of R3,119. This should put to rest the worries of investors.
This Monday—the redemption of the SGBs issued on August 5, 2016—the RBI will buy back 3.75 tonnes and it will buy back 3.6 tonnes on September 23, 2024 from the second tranche issued on September 23, 2016. The latest SGB issuance was on February 16, 2024 when the public bought 8 tonnes. So far, the RBI has outstanding 141 tonnes of gold to be redeemed.
The SGBs are nothing but Central government securities denominated in gold and issued by the Reserve Bank of India. It was launched to prevent the massive slide in the rupee on the back of the taper tantrums of the US Fed and the resultant flight of capital from domestic shores leaving the already high current account deficit ballooning further. Investors lapped up as many as 141 tonnes through the 44 issuances of these bonds. The scheme was introduced under the gold monetisation scheme to offer an alternative investment to physical gold, thus cutting imports and saving hugely on the scarce forex reserves.
All that glitters
The SGBs yield an annual interest of 2.5% payable half yearly and the redemption price is the average weekly price of the metal in the previous trading week as disclosed by the India Bullion & Jewellers Association.
It offers an assured 2.5% interest annually payable half yearly with applicable income tax on redemption but no capital gains tax.
While the August 5, 2016 issuance was priced at R3,119/g, the RBI announced its redemption price at R6,938/g, which is a full 122% over the buying price. The September issuance was priced at R3,151/g and the redemption prices will be the weekly average closing price of the 999-purity gold as published by the industry body.
An investor should take comfort from the fact that the redemption price is as low as they expected after the Budget decision. Already, investors earned 2.5% annually for the past 8 years, making 20% from the interest earned.
According to analysts, given the average 800 tonnes of gold imports, the government will lose around R1,200 crore in taxes foregone per annum after the duty cut but will save R59 crore per tonne now with the lower taxes and the resultant price correction.
Future of SGBs
With total government liabilities under the Sovereign Gold Bond scheme are likely to swell to R85,000 crore by March 2025 (budget estimate), the biggest doubt is whether the government will continue this scheme or not now as the duty cut has ensured that the import cost has come down by as many percentages as the quantum of the tax reduction itself.
The government has unofficially given more than enough hints that it is more likely to discontinue the scheme saying over the years it has been reducing the frequency of the issuances—most of the initial years it used to have 10 tranches in a year, then reduced to four and then to two—because the cost of financing fiscal deficit with SGBs and the benefits accruing from physical gold collection is disjunct.
An official decision on the fate of the scheme is expected before the second redemption on September 23. The unofficial version now is that since SGBs were launched as an investment instrument with a specific objective of curtailing gold imports and holdings, now that the customs duty is cut drastically there is no rationale for continuing it as the scheme is a more expensive way of funding the fiscal deficit.
However, given that it’s a bond with an eight-year maturity with no-pre-term exit option, there is no way an investor can come out of it before the maturity except within 21-day of the purchase.
Analysts are of the view that the customs duty cut aims at curbing gold smuggling and that the duty cut may only dampen demand for SGBs and remain an attractive investment due to the fixed annual interest rate and the high price of the metal which looks more likely to go up further than trend down. After all, many brokerages have a $2,700/ounce target for the metal by December.