Don’t give up on gold bonds yet

Dr Ajit Ranade
The scheme needs to be sold more aggressively, especially to small retail investors, in the hinterland
Sovereign gold bonds were introduced by the Union government eight years ago. Since then, these bonds, sold through the Reserve Bank of India (RBI) have been sold periodically every few months. So far, 62 such tranches have been sold. Each bond has a life of eight years, so the bonds sold in the first tranche have reached their end of life. They must be redeemed for actual cash. The government will accept the return of the bond, and deposit cash in the account of the investor. The investors have been able to buy these bonds in as small a value as five thousand rupees (equivalent to one gram) or as high as a few crores (equivalent to 4 kilograms of gold per individual).
These bonds have several advantages. Firstly, they are in demat form, so there is no need to physically hold any paper, unlike the old Kisan Vikas Patra or other such instruments. Secondly, the bond represents actual units of gold. So, it is like buying gold, only in demat form, which means that when you redeem the bond, it is like redeeming physical gold. You benefit from the price escalation in gold. The price escalates for two reasons. Gold becomes expensive when international speculators and bullion investors start buying it in huge quantities, as a safe-haven instrument. The gold price in India can escalate even as the rupee dollar exchange rate depreciates.
The third advantage of the gold bond is that it can be pledged as collateral for a loan. The fourth advantage is that capital gains made on the final sale of the bond are exempt from taxes. The fifth advantage is that the investor not only gets a double price escalation advantage of the bond gaining in value, but also a top-up of 2.5 per cent interest that the government gives to the investor.
When investors from the first tranche redeem their gold bonds, they will realise a post-tax gain of more than 12 per cent per annum over eight years. That is because the price of gold has more than doubled from Rs 2,684 per gram in November 2015 to about Rs 6,000 now. In addition to this, the rupee dollar rate has gone down from 62 to 82, a fall of 33 per cent. Thus, the investor has made a handsome annual gain of 12 per cent returns on a post-tax basis for eight years, as compared to stock market returns of around 13.8 per cent per year over the previous eight years. Keep in mind that the gold returns are risk-free and that the stock market has been booming, and yet gold has delivered handsome gains.
This column is not about investment advice. By selling demat gold bonds the government was hoping to reduce the insatiable appetite that Indians have for gold. Every year India imports around 1,000 tonnes of gold, with an average outgo of 50 to 80 billion dollars of precious foreign exchange. The government has imposed a stiff import duty of 12.5 per cent on gold. Alas, neither the gold bond scheme nor the stiff import duty has made any dent on the import of gold. Of course, the import of gold in 2022-23 was 24 per cent lower than the previous year. And the outgo is now at around 40 billion dollars, which is less than what it used to be. But the import of gold represents a drain on foreign exchange, which for a country with a trade deficit is bad news. The export of dollars also reduces the net benefit of foreign direct investment that comes into the country.
By selling gold bonds at fairly attractive terms to investors, the government was hoping to at least wean away some investors from physical gold. So far, the outstanding stock of gold represented by gold bonds is about 110 tonnes, just one tenth of our annual imports. The total borrowing by the government due to the sale of gold bonds is about Rs 64,000 crore. But the cost of this borrowing has been more than 10 per cent per annum, which is much more than the cost that the government pays for borrowing to plug the fiscal deficit. During much of the period between 2008 and 2020, the western nations were used to paying a cost of one per cent on their sovereign debt, and India was paying nearly six per cent. Now, thanks to inflation and monetary tightening, the cost of raising sovereign debt has gone up, but is still substantially lower than the cost of selling gold bonds. It is because of this reason that there is a rumble asking for the discontinuation of the sovereign gold bond scheme. It is too expensive, and it has not made a dent in the insatiable appetite for physical gold. But this would be hasty and premature. The gold bond scheme needs to be sold more aggressively, especially to small retail investors, in the hinterland. An upper limit of 2 kilos instead of 4 kilos can be kept. Sales can be enabled through smartphone-based apps rather than through banks and the RBI. The gold bonds can be made freely tradable. And the benefits of demat gold need to be advertised with much more intensity. Imagine a brand ambassador like Amitabh Bachchan selling sovereign gold bonds rather than only Kalyan jewellers’ products. The bonds can coexist with gold-backed exchange traded funds.
And the government can reduce its borrowing cost by hedging in international markets against gold price escalation and volatility. It can thus slice off at least one or two per cent of its cost by hedging using derivatives. This calls for some smart financial expertise at North Block, which is eminently possible. It is possible that the impact of gold bonds on physical gold will happen non-linearly. The government must also energetically introduce schemes to dematerialise gold in millions of households without using coercion or banning the ownership of gold, which is, of course, unthinkable in India.
This gold deposit scheme can coexist with the gold bond scheme and slowly but surely help bring gold wealth into the formal liquid financial sector.
(Dr Ajit Ranade is a noted economist.)