-By Anubha
Sovereign Gold Bonds (SGBs) have gained notable appeal among Indian investors lately, transforming from a niche investment vehicle to a mainstream asset class. This shift in investor sentiment is driven by several factors, including the increasing allure of gold as a hedge against inflation and economic uncertainties. Even though a significant portion of these bonds remains dormant in the market, a chunk of eager small investors are seeking to acquire older SGB series from the secondary market, indicating a robust demand for this financial instrument.
The Indian government has launched several series of SGBs, all of which are listed on the secondary markets and are available for trading in the cash segments of both the Bombay Stock Exchange(BSE) and the National Stock Exchange(NSE). This accessibility contributes to their growing popularity, as investors appreciate the dual benefits of earning interest while having the flexibility to trade these bonds if necessary.
The year 2024 saw the launch of only one SGB scheme, leading to a remarkable surge in inflows, which more than doubled to an impressive Rs. 7,367 crore, compared to Rs. 2,919 crore in 2023. This increase highlights not only the attractiveness of gold as an investment but also reflects the growing number of investor confidence in SGBs as a secure means of wealth.
Recently, the market has witnessed an astonishing demand for certain SGB series due to the absence of new issuance since the Reserve Bank of India issued 67 tranches between FY 2016 and 2024. This led to a surge in the prices of SGBs and resulted in trading them at a premium of 5 to 10% above their reference rates. For instance, the traded price of the series ‘SGBDEC25’ was recorded as Rs. 8,700, which is approximately Rs. 830, or 10% higher than the Indian Bullion and Jewellers Association’s (IBJA) reference rate of Rs. 7,869. This premium pricing is a reflection of not just the surging interest of Indian investors but also the limited availability of fresh SGB units.
SGBs are government securities, acting as a substitute for holding physical gold. They are issued in the denomination of grams of gold in the form of bonds by the Reserve Bank of India on behalf of the Government of India as a Government of India stock under Section 3 of the Government Securities Act, 2006. Investors pay the issue price in cash, and the bonds are redeemed in cash on maturity. The article discusses the factors contributing to the surge in demand for security and the noteworthy drawbacks of such investment.
What Makes SGBs Attractive?
Tax Benefits: Maximizing Your Return
SGBs are issued for a fixed period of 8 years. The previous norm was holding the SGBs subject to a 20% tax on the capital gains (with indexation benefits). After the Budget 2024, the long-term capital gain rate is now 12.5% of the tax burden and the short-term transfer of securities results in 15% of such liability.
The Holding Period: Understanding Commitment
As per the new budget proposals, all listed securities will now be considered long-term assets if held beyond 12 months, reducing the earlier span of 36 months. Since all SGBs are listed securities and can be traded in the secondary market, this change in tenure provides a solid ground for the boost in the demand for these securities among avid investors.
Buy Back Benefit: Cashing In with Ease
Unlike most of the traded securities in the capital market, the SGBs can be bought back by the RBI, starting from the 5th year of the issue of the security. The most fascinating attribute of this facility is the exemption of capital gain tax for the individual assessee on such redemption, since the Income Tax Act 1961 states that any gains arising on redemption or maturity of SGBs are not regarded as ‘transfer’.
Security: A Stable Investment Choice
The quantity of gold against the purchased price of the SGB is protected, providing a superior alternative to holding that amount of gold in physical form. In addition to eliminating the threat of storage, investors are assured of the market price of the gold at the end of the maturity period and receive periodical interest. SGBs are exempt from making charges and purity, contrary to the gold in jewelry form. Furthermore, the bonds are held in the books of RBI or demat form, eliminating the risk of loss or scrip.
Assured Interest
Unlike most of the securities traded in the market, SGBs are paired with the assured payment of a fixed annual interest rate of 2.5% (paid in semi-annual installments as per the new norms) on the nominal value of the security purchased.
Drawbacks: The Hidden Cost of Gold Bonds
Redemption Price: What You Need to Know
Investors who are buying SGBs at the premium in the current market are coupled with some exigent challenges over the next 5 to 6 years. If the gold prices do not appreciate sufficiently at the time of maturity, the investment is likely to disappoint the engrossed investors of today. The redemption price at maturity is calculated by taking the simple average of the closing price of 999 purity of gold of the last 3 business days before redemption. The rates are set forth by the IBJA, leaving a possibility of a marginal loss in the actual price of the gold received against the market price of the gold at the time of redemption. With a lock-in period of 5 years and a maturity span of 8 years, this long-term security is contingent on the prevailing market conditions to be considered successful.
Liquidity Complexities: Accessing Your Investment
Currently, the government is posing complexities in the issuance of the new SGBs, providing an affirmation of the heightened prices by limiting the supply of security. If the government resumes issuing follow-up SGBs, or if the market conditions pull the demand to the lower quadrant, the investors might be selling the SGBs at a discount, which were bought at a premium.
Interest Rates: Are They Really Worth It?
The 2.5% annual interest earned also earns tax liability for the investor, leading to a reduced net return. Subsequently, the interest is determined on the gold price that was prevailing in the market at the time of the security being issued and not on the current inflation-driven price of gold, nor is the premium considered for this purpose. This is also a robust reason for shrinking the interest of the buyers to purchase the SGB from the secondary market.
With revised lower tax rates, and assured interest income, SGBs are backed by certain supremacy over regular securities. The option to buy back these securities makes them an appealing investment in the capital market. Investors, promiscuous to holding the securities till their maturity can bet on them. However, SGBs are also clubbed with notable drawbacks. In the current market, SGBs are available with a residual maturity of seven and a half years in the secondary market, and with the prevailing volatility of the market, it is difficult to forecast the performance of these securities up to their holding period, which makes the practice of paying premiums for such securities for small and retail investors not recommendable.
Comments