Sovereign Gold Bonds – How Profitable have they been

22 Mar 2024 , 03:51 PM

HOW SOVEREIGN GOLD CHECKED ALL THE BOXES

For a long time, the Indian investors were looking for a solid gold investment product that would be reliable, simple, and profitable. In a sense, the sovereign gold bonds launched by the government of India in late 2015 checked all the boxes. It was simple in that you could invest in a bond that was linked to the market price of 24-carat gold. In addition, the value of the underlying gold holdings (in grams) was guaranteed by the government of India. Of course, the eventual returns would still depend on the performance of gold prices, but that has rarely disappointed investors and Indians, anyways, have a penchant for gold. These gold bonds could be held in certificate form or in demat form; either ways it saved them the hassles of physical ownership of gold and the related storage and insurance costs. In addition, there was also the additional discount on digital purchases of gold bonds.

But there were 2 other factors that added to the allure and attractiveness of these gold bonds. Firstly, these bonds paid a fixed interest on the face value of the bond. The government started by paying 2.75% which was later reduced to 2.50%, which is still attractive as it is over and above the gold price appreciation, if any. This interest payout was also guaranteed by the government, making it all the more credible. But, what really impressed the investors in these sovereign gold bonds (SGBs) was the tax treatment. As a special provision, the government made any capital gains made at redemption (after 8 years) fully tax-free in the hands of the investor. That is not only an incentive for investors to buy SGBs, but also an incentive to hold on for the full term.

QUICK PICTURE OF HOW GOLD BONDS FARED OVER THE YEARS

Since the first tranche issued in November 2015, the government has made a total of 67 sovereign gold bond (SGB) issues over the last 8 years. The table below, is a quick summary of the year-wise SGB sold by the government in term of grams of gold. The average price for the fiscal year is the arithmetic average of the price at which at which each of the tranches was sold by the government during the year. Here, financial year refers to the standard April to March cycle followed by the government of India.

Financial Year	Number of SGB Issues	Gold Bond Sales (in grams of Gold)	Average SGB Issue price (₹ per gram)	Total Funds Raised (₹ Crore)
FY2016	3	49,03,285	2,733.33	1,317.19
FY2017	4	1,13,87,765	3,054.75	3,480.57
FY2018	14	65,24,691	2,932.07	1,894.75
FY2019	6	20,30,873	3,183.67	643.17
FY2020	10	61,31,169	3,779.20	2,316.37
FY2021	12	3,23,51,961	4,926.00	16,048.74
FY2022	10	2,70,35,139	4,828.00	12,991.00
FY2023	4	1,22,60,868	5,327.00	6,550.66
FY2024	4	4,43,36,876	6,078.00	27,031.96

Data Source: RBI

Here is the macro picture. A total of 67 issues of SGBs have been made by the government as of March 22, 2024. This has resulted in total issue of 146.96 tonnes of gold (1 tonne is equal to 1 Million grams) via SGBs since November 2015. The total sum collected by the government through the issue of SGBs stands at ₹72,275 Crore cumulatively. The 3 best year in terms of SGB collection were FY24 (₹27,032 Crore), FY21 (₹16,049 Crore), and FY22 (₹12,991 Crore). These 3 years combined accounted for 78% of total cumulative collections by the government through the SGB route.

As of March 22, 2024, the total outstanding gold bonds are to the tune of 141.86 tonnes, indicating that a total of 5.10 tonnes of bonds have been redeemed. Out of these 5.10 tonnes of redemptions, a total of 3.78 tonnes reflected the full redemption of the first two tranches of SGBs issued. In addition, about 1.32 tonnes of gold bonds were redeemed by investors before the completion of 8 years through the 5-year and 6-year premature redemption window offered by the RBI. That brings us to the question, have investors really made money through their investment in sovereign gold bonds?

WHAT HAVE BEEN SGB RETURNS ON REDEMPTION?

That is an interesting question and it would be a function of 3 factors. Firstly, it would be a function of the capital gains, which is the difference between the redemption price and the issue price of that particular tranche. Secondly, this would get enhanced by the regular interest paid on the bonds on a half yearly basis. Thirdly, the long term gains, when held to maturity are entirely free of tax. Hence, to get the equivalent pre-tax returns, the return would have to be adjusted by the effective tax rate, adjusted for the price index factor.

Let us look at how this would have worked out for the first two tranches of sovereign gold bonds (SGBs) where the redemption has been completed. Obviously, we are not looking at the premature redemptions, since the data for the redemption price is not available and can vary from one person to another. The table below only captures the yields on the first two tranches of SGBs were the official 8-year redemption has been completed.

SGB Issue	SGB Issue Price (₹ per gram)	Redemption Price (₹ per gram)	CAGR Returns (%) for 8 years	Interest (Annual)	Yield to Maturity
Tranche 1	2,684	6,132	10.88%	2.75%	13.63%
Tranche 2	2,600	6,271	11.63%	2.75%	14.38%

Data Source: RBI

The first tranche had an issue date of November 30, 2015 and was redeemed on November 30, 2023. The second tranche had an issue date of February 08, 2024 and was redeemed on February 08, 2024. Here are some key takeaways from the analysis of the two redemptions.

The issue price and the redemption price are fixed by the government and the details of the first two tranches are available in the table below. Both the issue and redemptions are administered through the RBI. While the first SGB tranche CAGR return was 10.88%, the second SGB tranche had CAGR returns of 11.63%. That is not surprising considering that the price of gold has more than doubled during this period. In addition, the government has also paid out interest at 2.75% on the first two tranches. If you add up these two factors, then the total yield to maturity comes to 13.63% for the first tranche of SGB and 14.38% yield to maturity (YTM) for the second tranche of the SGB. Subsequently, the interest rate was reduced to 2.50% and the price of gold has also gone up. Hence, we need to see out the YTM of future bond redemptions work out. But, the effective returns would be still better than this, if you also factor in the tax exemption on long term capital gains.

SGB RETURNS ON TAX-EQUIVALENT BASIS (2 TRANCHES)

Till now we have seen how the CAGR returns on the gold bonds was enhanced by the interest paid to bring about an attractive YTM for the investors. We are only talking about the first two tranches of the SGB, where the redemption has already been completed. The table below captures the tax equivalent yields on these tranches of bonds.

SGB Issue	SGB Issue Price (₹ per gram)	Indexed Cost (₹ per gram)	Yield to Maturity	Tax Shield (index adjusted)	Effective Yield
Tranche 1	2,684	3,677	13.63%	14.24%	15.89%
Tranche 2	2,600	3,562	14.38%	14.76%	16.87%

Data Source: RBI

Here we are bringing in the tax equivalent yield for the first two tranches. Here are some basic points for you to remember.

• The sovereign gold bonds (SGBs) are fully tax-free if held for the full tenure of 8 years from the date of the issue. We all know that any non-equity index held for a period of more than 3 years is taxed at an LTCG rate of 20%. However, this is taxed at 20% only after the benefit of index.
• When the gains are tax free, then the effective returns have to be judged in pre-tax equivalent yield terms, which is the YTM adjusted for the saving of the effective rate. In this case, the effective tax shield for the first two tranches stand at 14.24% and 14.76% respectively.
• When the YTM is adjusted this tax shield, the effective yield in tax equivalent terms goes up further to 15.89% for the first tranche and 16.87% for the second tranche. This is very attractive effective returns over a period of 8 years, considering that this is a debt product with only price risk and zero default risk due to the government guarantee.

Of course, we are looking at a case of a gold tranche which was issued close to a recent low and redeemed at close to an all-time high. Hence, the yields that we have seen may not be representative or even reflective of future yields. That is something investors must keep in mind. But going by the experience of the first 2 tranches, the yields have been very attractive.

KEY FACTORS TO KNOW ABOUT SOVEREIGN GOLD BOND RETURNS

While we have seen an illustrative of the CAGR returns, YTM and the effective pre-tax equivalent yield of the first two tranches of SGBs, here are some points to keep in mind about such yields in future.

• As stated earlier, the 8 year period considered in the first two tranches showed the journey from a low level to a high level. That explains the attractive yields. Today, SGBs are being issued at above ₹6,000 per gram, so future returns could be a lot more laboured for the investors.
• The interest rate was 2.75% in the first two tranches. However, subsequently, the interest rate was reduced to 2.50%. That would have an impact on the yield on these sovereign gold bonds, although it would be just about 25 bps, but it would really matter if yields start compressing as the rally in gold starts to slow.
• The tax equivalent yield in this case is much higher because the sovereign gold bonds were held for the full maturity period of 8 years. However, this benefit of tax free long term capital gains is not available if redeemed earlier. Hence, if you sell the bonds in the secondary market (subject to liquidity) or if you redeem in the 5-year window or 6-year window, then you do not get the tax exemption and that would impact your tax equivalent yields.
• There is also an inflation factor that goes into the index numbers under the Income Tax Act which impacts the indexed cost of acquisition of these sovereign gold bonds. In this case, the assumed inflation in the 8-year period is 4.01%. However, if the inflation were to move higher, then the tax would be lower and the tax shield would also be lower. That would reduce the tax-equivalent yield.

The yield on the sovereign gold bonds in the coming tranches will be a function of all these factors above. For now, one thing is certain. Sovereign gold bonds have not only emerged as a safe and flexible option to investing directly in gold; but it has also emerged as a very profitable investment vehicle to earn above market returns. That is the message; at least from the first two tranche redemptions of the sovereign gold bonds.