How successful have Sovereign Gold Bonds been in India?

1 Jun 2024 , 03:28 PM

HOW MUCH MONEY HAVE SOVEREIGN GOLD BONDS RAISED IN INDIA

For years, gold has been an investment that has not let investors down. Can the same be said about the sovereign gold bonds in India? Remember, sovereign gold bonds (SGBs) were first issued in India in the year 2015. Between FY16 and FY24, it has been more than 8 years since gold bonds have been around in India. Here is a quick summary of the quantum of gold bonds issued in India by the government and the amounts raised.

Financial Year	Number of Tranches	Gold Units Bought (Quantity in Grams)	Value of Purchase (₹ in Crore)
FY16	3	49,03,285	1,317.91
FY17	4	1,13,87,765	3,480.57
FY18	14	65,24,691	1,894.75
FY19	6	20,30,873	643.17
FY20	10	61,31,169	2,316.37
FY21	12	3,23,51,961	16,048.74
FY22	10	2,70,35,139	12,991.00
FY23	4	1,22,60,868	6,550.66
FY24	4	4,43,35,778	27,031.27
Grand Total	67	14,69,61,529	72,274.45

Data Source: RBI

This may look like a maze of numbers, so let us quickly try and decipher what these numbers mean. Here are some key takeaways.

• Since the first tranche of sovereign gold bonds were issued in late 2015, there have been a total of 67 tranches issued by the government of India through the RBI. The maximum tranches were issued in the fiscal FY18 (14 tranches) followed by FY21 (12 tranches). In addition, there were 10 tranches of the SGBs issued in FY20 and FY22 also. You can see a clear concentration of these issue of sovereign gold bonds around the pandemic period.
• How many grams of gold have been issued by the government of India overall to the Indian investors through the sovereign gold bonds? A total of 146.96 Million grams have been sold to the public till date in the last 8 years with the issue price of each tranche varying depending in the prevailing price of gold. Out of these 146.96 Million grams of gold issued via sovereign gold bonds, a total of 6.20 Million grams of gold have been redeemed by the investors, while the balance 140.76 Million grams are still held by the investors. Remember, the sovereign gold bonds are redeemed fully by the government at the end of 8 years. However, in the interim, redemption is possible through the special window after the fifth and the sixth year.
• Would the gold bonds have been a profitable proposition over the last 67 tranches? Of course, each of these tranches were done at different prices. What we can do is to arrive at an arithmetic average price of the last 67 tranches. That comes ₹4,050 per gram. So, person who had bought 1 gram of sovereign gold bonds (SGBs) in each of the tranches would be sitting on 67 grams at an average price of ₹4,050 per gram. That translates into an investment of ₹2,71,350, which at the current market price of ₹7,400 per gram would have been worth ₹4,95,800. In short, your gold portfolio has appreciated by 82.72%.
• Finally, let us look at the overall wealth created by these sovereign gold bonds (SGBs) over the last 8 years for the investors in terms of difference between the cost price and the current market price. The total investment in gold bonds till date of ₹723 Billion would be worth ₹1,321 Billion, which is an overall wealth creation of nearly ₹600 Billion or ₹60,000 Crore through the issue of sovereign gold bonds (SGBs). Remember, SGBs are only meant for domestic investors, so this entire wealth of ₹60,000 Crore has been created within India only.

An important point to remember here is that the gains on investing in sovereign gold bonds (SGBs) is not limited only to the appreciation in gold prices. These bonds pay an interest of 2.5% and the capital gains are entirely in the hands of the investors if held for 8 years. Therefore, the pre-tax equivalent returns would be much higher. Let us look at these effective returns for the first 3 tranches of sovereign gold bonds (SGBs) which have been fully redeemed by the government of India, on completion of 8 years.

HOW MUCH DID YOU EARN ON THE FIRST 3 SGB REDEMPTIONS?

Till date, the final redemptions have only happened in the first 3 tranches of sovereign gold bonds (SGBs), where the 8-year tenure has been completed. These are the 2015-I tranche, 2016-I tranche, and the 2016-II tranche. The ideal way to calculate returns would be the IRR, but that would unnecessary complicate things. Instead, we will calculate the CAGR returns over an 8 year period for these 3 tranches of sovereign gold bonds (SGBs) and then adjust the returns for the interest amount and the tax impact. The table below captures the first 3 tranches of sovereign gold bonds (SGBs) that have been redeemed till date.

SGB Tranche	Issue Price	Redemption Price	CAGR Yield	Interest earned	Effective Yield
2015-I	2,684	6,132	10.880%	2.50%	13.380%
2016-I	2,600	6,271	11.635%	2.50%	14.135%
2016-II	2,916	6,601	10.753%	2.50%	13.253%

Data Source: RBI

The above table are based on actual prices at which the government issued the first 3 tranches of sovereign gold bonds (SGBs) and also the actual price at which these tranches of sovereign gold bonds (SGBs) were redeemed through the RBI. The first tranche paid 2.75% interest, but we have ignored that to keep it simple. Look at the last column, which captures the effective yield that the investors would have earned including the appreciation in gold prices and the interest received annually. This is fairly reflective of what the investors in these sovereign gold bonds (SGBs) would have actually earned on an annualized basis. Thesa are attractive returns by any measure as they not only beat inflation by a margin, but also beat other asset classes like bonds and hybrid assets and also come with a lot of safety due to the government guarantee on the core gold holdings and the interest payment.

However, this is not the full returns that the investors get. In the above table, while the interest component is taxable at the extant peak incremental rate for the investor, the capital gains made by the investor is fully tax free since the bonds have been held for the full tenure of 8 years. How would that change the tax calculation? It would depend on the tax bracket you belong to and for that you need to evaluate the returns under different tax brackets. Here is how it would look.

HOW DO SGB RETURNS LOOK IN TAX-ADJUSTED TERMS?

We will now look at how these returns look in tax-adjusted returns. We will treat the capital gains differently and the interest differently as the interest is taxable while the capital gains is not. The table below captures how the tax-adjusted returns will look like under different tax rate scenarios. The base yield will be 10.880%, 11.635%, and 10.753% for the 3 tranches.

SGB Tranche	Pre-Tax Yield (10% Tax)	Pre-Tax Yield (20% Tax)	Pre-Tax Yield (30% Tax)	Interest earned	Best Effective Yield
2015-I	12.089%	13.600%	15.543%	2.50%	18.043%
2016-I	12.928%	14.544%	16.621%	2.50%	19.121%
2016-II	11.948%	13.441%	15.361%	2.50%	17.861%

Now we get the actual effective returns in tax adjusted terms earned by the investors in the first 3 tranches that have already been redeemed by the government of India. The tax-adjusted yield depends on the tax bracket you are in and higher the tax bracket you are in, higher is the effective pre-tax yield that you enjoy. In the above calculation, only the capital gains are tax free and hence are adjusted to pre-tax equivalent terms. The interest earned is taxable, hence it has been considered as it is. The moral of the story is that gold bond are safe instruments fully free of default risk as far as the quantum of gold and the interest payment is concerned. In the first 3 tranches, the best yield for those in the highest tax bracket has been 18.34% on an average. Let us quickly look at for whom the sovereign gold bonds make a lot of investment sense.

FOR WHOM THE GOLD BONDS ADD VALUE

Investors often wonder whether they should invest in gold bonds and how much. Here are a few pointers that will help them decide.

• According to a study by the IMF, the average returns on gold between the year 1971 and 2019 has been 10.6%. Over an 8 year period, there are very few occasions in which gold have given negative returns. We decided to do this actual gold price study in the Indian context between 2006 and 2023.
• What we found was quite amazing. Had you bought gold in any of the bonds between December 2014 and December 2013, then the 8-year returns (holding period for SGBs) would have been positive only. But more interesting is the actual numbers that we arrived at based on the table.
• Over all these 8 year periods (we did the exercise monthly) between December 2014 and December 2023, the average returns was 92.21%. There is more to it. The maximum returns you would have earned on gold over an 8 year stretch would have been 208.95%. More importantly, the minimum returns would have been around 30.87%. Even if you were very unlucky, you would not have been too badly off. Remember, in the case of these sovereign gold bonds, there is the interest of 2.5% on top of that.
• The moral of the story is that it would be very difficult to earn negative returns on gold if held for 8 years and on an average you would be surely better than inflation, even without counting the interesting paid on the SGBs.

What investors must remember is that buying and holding SGBs is a much simpler, safer, and more economical means of holding gold. It comes with the additional benefit of a government guarantee on the quantum of gold held in grams as well as the interest payout. To top it, the capital gains on the gold bonds, if held for a full 8 years is entirely tax free, so that makes the effective returns much higher.

However, there is one point that investors must bear in mind. Gold is not a growth / income asset like equity and debt. The big advantage it brings to the portfolios is that of a hedge. It gives protection because gold does exceptionally well in times of political, geopolitical, and economic strife. Adding gold to the tune of 10% to 15% exposure in the portfolio, actually reduces the risk and enhances the long term returns of the portfolio. After all, gold is one of the few assets that tends to have a negative correlation with equities. Adding gold does make the portfolio more robust and buffered.

ARE THERE ANY DOWNSIDES TO SOVEREIGN GOLD BONDS?

Broadly, there are 4 factors that weigh against sovereign gold bonds; although they may not be too serious.

• Unlike gold ETFs, the sovereign gold bonds (SGBs) are not available on tap or cannot be bought directly with the trading and demat account. One has to wait for the RBI to announce a tranche of gold bonds.
• Secondary market liquidity in gold bonds is very limited. The trading in gold bonds is quite thin and while the government does offer an exit window to the holders of sovereign gold bonds (SGBs) through premature redemptions after 5 years and 6 years, it means that the investor has to forfeit the capital gains tax exemption.
• The tax exemption holding period for sovereign gold bonds (SGBs) is quite long at 8 years. In contrast, the holding period is much shorter for concessional returns in the case of gold funds and gold ETFs.
• Most investors have seen gold having a good run since the global financial crisis of 2008. However, gold had a long period of stagnation between 1981 and 1999. Hence there is a possibility that investors may become unnecessary sanguine about gold.

The bottom line is that the advantages and the performance of gold in the last 8 years far outweighs these shortfalls. Sovereign gold bonds (SGBs) have surely emerged as a potent way to invest in gold without the hassles of physical gold holding. It surely offers  smarter way to hedge your portfolio!