The Government’s Close Call: Will SGBs Be Phased Out for Good?
India’s Struggle to Reduce Gold Imports
India: A Top Gold Importer
India consistently ranks among the top global gold importers, accounting for nearly 800-1,000 tonnes of gold imports annually. This level of consumption has a direct impact on the country’s trade deficit, as India spends billions on importing gold, which is mostly used in jewelry, investment, and religious purposes.
Import Duties on Gold to Deter Consumption
In an effort to curb the overwhelming demand for gold, the government introduced import duties on gold imports starting in the early 2010s. Initially set at 2%, these duties aimed to make gold more expensive and, therefore, less attractive to consumers.
Rising Duties as Imports Continued
Despite the initial duties, gold imports remained robust, prompting the government to repeatedly hike the import duty. By 2013, the duty was raised to 10%, and it continued to increase as gold remained in high demand. This approach sought to discourage gold buyers by driving up prices domestically.
The Launch of Sovereign Gold Bonds (SGBs)
In 2015, the government introduced the SGB scheme as a more structured approach to reducing physical gold purchases. Investors in SGBs could invest in gold without physically buying it. The government offered a 2.5% annual interest rate and exempted capital gains tax if the bonds were held until maturity. This was designed to encourage financial savings while reducing the nation’s reliance on imported gold.
How the Recent Reduction in Customs Duty Affected SGB Holders
At the time when most SGBs were issued, customs duties on gold were over 10%. This higher duty kept the price of gold elevated in the domestic market, benefiting SGB holders as gold prices rose. However, in 2024, the government reduced the customs duty on gold from 15% to 6%. While this helped lower the price of gold for new buyers, it had a negative impact on existing SGB holders. The price of gold has surged by around 16% since July 2024, reaching ₹78,919 per 10 grams in October, a lifetime high. Despite this price increase, SGB holders missed out on around 5% of the gains due to the reduction in customs duty. While new buyers benefited from lower prices, the reduced duty meant that SGBs didn’t fully capture the price surge. Fortunately, the 2.5% annual interest on SGBs serves as a cushion, helping to offset the loss caused by the customs duty cut. Over the years, this cumulative interest may compensate for the reduced price appreciation. As customs duty stands at 6%, there is always the possibility that the government could lower it further. If that happens, the price of gold would adjust again, potentially impacting the returns of SGB holders compared.
SGB Maturity: 128% Returns for Early Investors
To illustrate the potential returns from the first SGB issuance upon maturity, let’s look at a specific example as illustrate in a Economics Times article. If an investor purchased 35 grams of gold during the initial SGB offering at ₹2,684 per gram, the total investment would have been ₹93,940. Fast forward to maturity, with a redemption price of ₹6,132 per gram, the investor would now receive ₹2,14,620. This represents a remarkable 128.5% return on investment, excluding the 2.5% annual interest earned through the bond.
In terms of Compounded Annual Growth Rate (CAGR), this translates to a return of 10.88%. Furthermore, as of today, approximately 10.47211 tons of SGBs have matured, showing a strong track record for this investment vehicle. Investors are benefiting from significant growth, particularly in a market where gold prices continue to rise steadily.
Why Has the Government Not Issued SGBs in FY 2025?
The main goal behind the introduction of SGBs was to discourage physical gold buying. However, despite the availability of SGBs, the data on gold imports shows that physical gold remains highly popular, with SGBs capturing only a small portion of total demand. Data suggests that while SGBs have provided an alternative, they haven’t significantly reduced physical gold purchases. Indians still heavily favor physical gold, leading to a continuous flow of imports. In FY 2025, the government has not issued SGB. One reason could be the lackluster performance of SGBs in curbing gold imports. Moreover, when the government can borrow through debt instruments at interest rates of 6-6.5%, issuing SGBs at 2.5% interest, coupled with the risk of rising gold prices, may seem less attractive. Another factor at play is the fiscal risk associated with SGBs. When the SGB mature, the government must pay the market price of gold, which could rise significantly over time. Had there been 10 times more subscriptions to SGBs, the government’s fiscal position could have been strained by the high redemption payouts. The relatively low subscription levels so far have allowed the government to escape this potential burden, but increasing subscription could pose a fiscal challenge.
Conclusion
While the Sovereign Gold Bond (SGB) scheme was launched with the intent of reducing India’s physical gold consumption, the overall impact has been limited. Recent reductions in customs duties have inadvertently hurt SGB holders by reducing potential price gains, though the interest payments offer some consolation. Given the minimal success of the scheme in cutting down gold imports and the fiscal risk it poses, it seems likely that the government may reduce or even stop the issuance of new SGBs in the future.
India’s love for physical gold continues to drive imports, and despite several policy interventions, including import duties and SGBs, the nation remains heavily reliant on the yellow metal.