Gold customs duty may take some shine off Sovereign Gold Bonds

The redemption value of the SGBs is linked to the prevailing price of gold at the time of redemption, and therefore, any move that could hit gold prices is bound to impact the redemption value as well. SGBs issued under Series I of 2016-17, which were issued on August 5, 2016, are up for redemption in the first week of August. These investors are likely to be the first to witness lower-than-expected returns on their investment due to the customs duty cut.

These SGBs were issued at a price of Rs 3,119, and going by prevailing gold prices the value appreciation has been over a hundred per cent, in addition to the interest earned by investors over the eight-year period. The redemption price of SGBs is fixed on the basis of the previous week’s (Monday-Friday) simple average closing price for gold of 999 purity, published by the India Bullion and Jewellers Association Ltd (IBJA).

SGB 2016 Series II bonds, which came up for redemption in March this year, gave a return of 126.4 per cent over the investment value, in addition to the interest paid to investors over the eight-year holding period.

Dent to expected returns

On the day of the Budget, gold prices fell nearly 5 per cent. The gold spot price on MCX fell to Rs 69,296 per 10 grams on July 23, compared to Rs 72,875 per 10 grams on July 22. The decline in gold prices, following the customs duty reduction on the precious metal, has impacted returns on all gold investments, including SGBs, physical gold and gold exchange traded funds (ETFs).

“This series (SGB 2016-17) was issued at Rs 3,119 per gram price. As per the current price of Rs 6,853 per gram, the returns are around 10.40 per cent compounded annual growth rate (CAGR) and 120 per cent ( in absolute terms), and if the duty was not changed then the returns would have been 6-7 per cent more,” explained Satish Dondapati, Fund Manager, Kotak Mahindra AMC.

“SGBs are valued based on gold prices. For SGB holders, the reduction in customs duty has resulted in a decline in gold prices that they own, and therefore, the returns that they will get from SGBs will decline,” said Chirag Mehta, Chief Investment Officer, Quantum Mutual Fund.

On the NSE, SGBAUG24 (SGBs up for redemption in August this year) declined 2.62 per cent to close at Rs 7,275 per unit on July 23, compared to Rs 7471.11 per unit on July 22. As there are multiple series of SGBs issued at different price levels and at different points in time over the years, the fall in SGB value varied across issuances. The steep decline was seen mainly in the high-volume SGB series.

“If we were to look at the top-five series, the average decline in (SGB value) was -3.8 per cent at intraday low and -2.8 per cent at closing,” said Sriram BKR Senior Investment Strategist Geojit Financial Services.

As per market participants, 95 per cent of total SGBs issued so far are outstanding. In terms of kilogram (kg), the total SGB outstanding is 1,40,748 kg or 140.8 tonnes, which, at the current gold price, is equivalent to over Rs 96,000 crore, said Sriram.

The lucrativeness of SGBs

The SGB Scheme was launched by the government in November 2015, as part of the Gold Monetisation Scheme. The Reserve Bank of India (RBI) in consultation with the government launches SGBs for subscription in tranches. Over the years, the SGBs gained popularity among risk-averse investors looking to invest in gold-linked instruments that were safe and secure. Many also see the SGBs as the best option available in the market to diversify their investment portfolios by adding gold price-linked investments. Within the gold and gold-linked investments category, SGBs emerged as a top choice, and not without reason.

Given that the SGBs are issued by an institution like the RBI, the scheme has very high credibility. These bonds offer 2.5 per cent simple interest per annum—paid semi-annually—on the purchase value. If held till maturity—a period of eight years—the cumulative interest income comes out to be 20 per cent of the purchase value. And this is over and above the redemption value—essentially the value of gold at the time of redemption—that has the asset appreciation value built in. Physical gold and most other gold-linked instruments do not offer any additional gains beyond asset value appreciation.

The other major advantage of SGBs is that the redemption on maturity is free of any LTCG tax. Additionally, SGBs are tradable on the exchanges and unlike buying physical gold, there is no cost or concern associated with the storage and safety of these bonds.

Despite the likely impact of the gold duty cut on SGBs’ redemption value, the instrument continues to remain attractive, at least in the category of gold and linked investments, industry insiders feel. Analysts said the reduction in gold prices will lead to an increase in domestic demand for the yellow metal, which could push up prices in the domestic market over time. With the festival and wedding season nearing, the demand for gold will further rise.

“If demand rises, gold prices will increase as well. Due to high demand and price stabilization we may see gold prices moving north. There will not be any large impact from the long term perspective,” said Sudeshna Saha, Product Lead, IIFL Securities.