Editorial. Sovereign gold bonds should be phased out

The Sovereign Gold Bonds (SGBs) scheme has completed eight years since its inception with the first tranche coming up for redemption this month-end. Gold prices have more than doubled over the issue price; hence, investors in this tranche stand to make a killing with annualised returns of nearly 11 per cent from gold price appreciation, apart from the 2.75 per cent annual interest they have earned. Despite such returns to investors though, the SGB scheme must be judged a failure.

Launched in the backdrop of an unsustainably high current account deficit (4.8 per cent of GDP for FY13) caused by uncontrolled gold imports, SGBs, along with the gold monetisation scheme, were designed to bring about a permanent reduction in India’s gold import bill. SGBs were to be issued and redeemed by the Centre at prevailing market prices of gold with the interest payout and a capital gains tax exemption tagged on as sweeteners. Policymakers hoped that households would cut back on their purchases of physical gold, which entails costs such as making charges and storage, to latch on to a government-backed instrument with better returns. But thanks to the lukewarm response to successive SGB issues, their outstanding stock today represents just over 120 tonnes of gold. SGBs have made scarcely a dent in India’s bullion imports which have ranged between 700 and 1,100 tonnes annually in recent years. For households purchasing jewellery for weddings and other occasions, SGBs are obviously a poor substitute. Lower-income households who stash their rainy-day savings in bullion prefer physical gold for its ability to generate instant liquidity when pledged with the local moneylender. For investors keen to own gold as a trading bet or diversifier, gold exchange traded funds which are available on tap, have proved more useful than SGBs — which are issued and redeemed at a time of the Reserve Bank of India’s choosing.

The Centre, however, has reason to be relieved that the SGB scheme has not taken off, as it is a high-cost borrowing it can ill-afford. Recurring crises have led to global gold prices nearly doubling since 2015, even as the rupee has depreciated from about 65 to 83 to a dollar. SGB borrowings have turned out to be much dearer for the Centre than plain-vanilla borrowings from the domestic bond market at a time of low interest rates. Given gold’s propensity to lie low for long periods but shoot up sharply when global geopolitical or financial risks loom, the Centre has taken on significant price risks on its SGB obligations — which it has so far left unhedged, and unwisely so.

In any case, the Centre importing physical gold to back its SGB dues would defeat the very purpose of the scheme, while hedging in the derivatives market could escalate costs. All things considered it may be prudent for the Centre to phase out SGBs, before investors decide to flock to them attracted by the returns from the first tranche.

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