The week of September 11, India’s central bank launched the latest sovereign gold bond (SGB) issuance, under which the government issues bonds linked to the price of gold to investors. For the government, it is a way of raising funds to meet its needs, whether to finance public spending or to fill gaping deficits. For investors, it is an investment option, made attractive in recent years by the strong performance of gold as an asset class. However, this should not be taken for granted.
The week of September 11, India’s central bank launched the latest sovereign gold bond (SGB) issuance, under which the government issues bonds linked to the price of gold to investors. For the government, it is a way of raising funds to meet its needs, whether to finance public spending or to fill gaping deficits. For investors, it is an investment option, made attractive in recent years by the strong performance of gold as an asset class. However, this should not be taken for granted.
Gold price data from the Reserve Bank of India for this century shows that 5-year average gold returns – the effective lock-in of the SGB program – have exceeded 10% in 12 of the 22 financial years , including the last three financial years. years. But there were also 10 years during this block where gold’s 5-year average returns were in the single digits or even negative. In other words, even though gold is less volatile than, say, stocks, it is not a safe investment option.
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Gold price data from the Reserve Bank of India for this century shows that 5-year average gold returns – the effective lock-in of the SGB program – have exceeded 10% in 12 of the 22 financial years , including the last three financial years. years. But there were also 10 years during this block where gold’s 5-year average returns were in the single digits or even negative. In other words, even though gold is less volatile than, say, stocks, it is not a safe investment option.
In general, interest in asset classes tends to sync up with their recent performance. Gold is rising. Between May 2019 and August 2020, for example, gold prices rose from ₹3,173 per gram at ₹5,291 per gram, an increase of 66% in 16 months. It was also around this time that subscriptions to the SGB program began to increase. August 2020 recorded the highest volume of 6,350 kg (each bond equals one gram of gold) till then. Last June’s SGB show surpassed it with 7,769 kg. This is the wind behind the latest issue of the SGB.
About the program
The first SGB was announced in November 2015. In total, there have been 64 SGB issues, raising a total of approximately ₹50,000 billion. As of March 2023, the total amount outstanding under the SGB and another available program, gold monetization diagram – was there ₹58 trillion. However, this represents only a fraction of the government’s immense financing needs. For 2023-24, the projected budget deficit is ₹17.9 trillion.
Under the SGB system, 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 Jewelers Association (IBJA) in the days preceding the issue. The term of office is eight years, although buyout is permitted after five years. The bonds are redeemed at the average gold price prevailing on the redemption date. Additionally, the government pays interest of 2.5% per year. While interest earned is taxed, capital gains are not.
Low redemptions
Taking into account the five-year period, buybacks under the SGB program began in 2021. Buybacks are carried out at a price announced by the government, which is linked to the average daily price announced by the IBJA in the days preceding the repayment date. As of 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 period of 5 years – is between 47% and 94% compared to the respective issue price. Despite this return, the majority of the bonds were not repaid by investors. As of June 2023, only 6% of bonds eligible for reimbursement had been returned to the state. This may in part reflect the complexity of the redemption process, which involves submitting early redemption requests at least 10 days before the redemption date, accompanied by identification documents.
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The low redemption rate also reflects gold’s recent strong performance as an asset class. The total return on bonds includes interest income and capital gains if the redemption price is higher than the issue price. In this sense, the “bond” has an equity component, which implies a bet that the price of gold will be significantly higher at the time of redemption than the issue price.
For the 22 SGB issues that have begun redemption, the average annual pre-tax bond yield after five years has been between 10% and 16%, depending on the tranche and maturity date. Even though these yields are much higher than what Bank deposits supply, only in the most recent seven tranches have returns exceeded the total return of the NSE Clever 50 actions over the same period. . Although data on collections from the latest edition is not available, gold returns should not be taken for granted.
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