SGB- India’s New Initiative to Control Gold Imports

First it was 80:20 Scheme by earlier government, then the Gold Monetization Scheme (GMS) and now the latest one is Sovereign Gold Bonds (SGBs)- both the later ones are recently introduced by the new government of India.

We have frequently mentioned here that the Indian government has always remained watchful to control the troublesome Current Account Deficit (CAD) and to bring down its heavy import bills. As a result, imports of gold, being a non-productive asset have become the prime target of the government which has time and again tried to discourage physical demand of gold to reduce the inflow of the yellow metal into the country.

Although the 80:20 Scheme introduced by the earlier government has been withdrawn among the strong opposition of the industry circles, both the new schemes- GMS and SGB proposed by the new government have been widely welcomed here by India’s bullion & jewellery industry.

While the GMS aims to dig out the huge amount (about 24,000 tons) of gold lying unproductively in people’s safes (we have already discussed the pros & cons of the scheme here earlier), the SGB Scheme discourages people from possessing physical gold and instead inspires them to invest in ‘paper gold’ to be introduced by the Reserve Bank of India (RBI) on behalf of the Indian government. The draft outline (for discussion purposes only) has been published on the 18th June and the Finance Ministry has invited the public to submit their comments on the proposals by 2nd July, 2015.

Accordingly, the government expects around Rs.13,500 crore to be invested in the bonds which is equivalent to 50 tons of gold. As per the scheme, investment and redemption would be by paying money but linked to gold price. The government would also consider providing capital gains tax the same treatment as for physical gold. While gold price rise & fall benefit would be passed on to the investors, issuing agency, (RBI), will not have to bear the price risk, nor hedge it and, the government would bear the risk of gold price movement on issuances.

Contrary to the GMS, where the primary aim is to ‘monetize’ India’s massive stock of physical gold, the SGB scheme targets to convert the investment demand for physical gold into paper demand. The SGBs which would be issued in denominations of 2, 5 and 10 grams of gold with a minimum tenor of 5 to 7 years, would be linked to the price of gold. Mr. Somasundaram P.R. MD, India, World Gold Council (WGC) says, “Any step that increases consumer choices and makes gold a fungible asset class is good. WGC’s research confirms the increasing interest of the Indian consumers for interest-bearing gold-based investment products.”

India’s investment demand for gold was at 181 tons in 2014 against an average annual demand of 345 tons from 2010 to 2013. If the scheme is subscribed fully in the first year, it would represent 27% of the 2014 investment demand and would result in savings of $2 billion on gold imports at current prices, mentions the scheme draft. Prominently, a 2% lower limit of interest rate has been indicated and would be paid in terms of gold grams. On maturity, the investor would get an amount equivalent to the face value of gold in Rupee terms.

Primarily, the scheme seems to be widely welcomed by the industry but the government may change some of its provisions according to the suggestions it would receive from the industry leaders and the consumers.

Posted by Suresh Chotai