Following the Budget announcement to cut the import duty on gold, the government plans to make a final decision regarding the future of the Sovereign Gold Bonds (SGB) scheme in September.
Sources indicate that the cost of financing the fiscal deficit through SGBs is quite high and does not align with the benefits accruing to investors from the scheme. This disparity may lead the government to decide on discontinuing the scheme at the upcoming meeting next month, which will also determine the official borrowing amount for the second half of the financial year.
“Earlier, we used to have 10 tranches in a year, then we came down to four and then to two. That was a very conscious way of seeing that the cost of financing fiscal deficit and the benefits accruing from physical gold collection is disjunct. We will take a call in September when we hold the borrowing meeting to decide on whether we should issue a tranche this year or not keeping in mind that it should benefit both the investors and the government,” an official said.
Domestic gold prices have fallen by nearly 5 per cent since July 23, when Finance Minister Nirmala Sitharaman reduced the customs duty on gold from 15 per cent to 6 per cent—the lowest in over a decade. While this duty cut led to a decrease in gold prices, it also resulted in increased demand for the metal.
“SGBs were brought in as an investment (instrument) with a specific objective of curtailing gold imports and holdings. But now that we have reduced the duty, we’ll see how to go about it,” the official said.
The official also mentioned that the SGB scheme is one of the more expensive instruments for funding the fiscal deficit. A comprehensive decision must be made about whether to continue it, as it is not a social sector scheme but rather an investment option.
Some analysts believe the customs duty reduction aims to curb gold smuggling, which has increased due to recent high gold prices. Although the duty cut might dampen demand for these bonds, they remain an attractive investment due to the fixed annual interest rate of 2.5 per cent, payable semi-annually.
In the Budget presented on July 23, the government reduced the gross SGB issuances to Rs 18,500 crore from Rs 29,638 crore in the interim budget of February 1. Net borrowing through SGBs has been cut to Rs 15,000 crore from Rs 26,138 crore previously estimated.
“It is one of the most expensive instruments to fund the fiscal deficit,” an official said, adding that a decision will be made in September during the meeting to determine the borrowing plan with the Reserve Bank of India. The government will decide whether there will be new issuances this year, ensuring they benefit both investors and the government.
“Whether we would like to continue or not, a holistic decision has to be taken going forward. It is not a social security scheme but an investment option,” the official added.
The Government of India finances its fiscal deficit through various instruments, including dated securities, the National Small Savings Fund (NSSF), provident funds, and SGBs.
SGBs issued under Series I of 2016-17, which were released on August 5, 2016, are up for redemption in the first week of August. These investors are expected to experience lower-than-expected returns due to the customs duty cut. These SGBs were issued at a price of Rs 3,119, and given the current gold prices, the value appreciation has exceeded 100 percent, in addition to the interest earned over the eight-year period.
SGB Series II bonds from 2016, which were redeemed in March this year, provided a return of 126.4 per cent over the investment value, along with the interest paid over the eight-year holding period.
The reduction in gold prices following the customs duty cut has impacted returns on all gold investments, including SGBs, physical gold, and gold exchange-traded funds (ETFs), with the compound annual growth rate (CAGR) now expected to be around 10-11 per cent. This could have been 6-7 per cent higher if there had been no duty cut, according to an analyst.
On sovereign green bonds, the official said the government plans to issue papers worth around Rs 20,000 crore in the current financial year.
However, it will monitor the greenium (premium associated with a lower borrowing cost for the government) closely, as the premium was only 1-2 basis points last year.
Sources indicate that the cost of financing the fiscal deficit through SGBs is quite high and does not align with the benefits accruing to investors from the scheme. 
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