Sovereign Gold Bonds – Pros and Cons

Gold has always been a coveted asset in jewelry and as an investment. Though expensive, gold is considered auspicious, especially in India. But buying and storing physical gold has its downsides – risk of theft and costs of storage and maintenance. Gold is a good hedge against inflation, but physical gold doesn’t give any returns and has only appreciated marginally over the years.

In November 2015, the Government of India introduced Sovereign Gold Bonds (SGBs) to make investing in gold more easy. Unlike gold bars, SGBs give a fixed percentage of interest.

What are Sovereign Gold Bonds (SGBs)?

The Reserve Bank of India (RBI) issues Sovereign Gold Bonds on behalf of the Government of India. These bonds are an alternative to physical gold and are available in grams. The bonds mature in 8 years but can be redeemed early with RBI after 5 years. SGBs can also be traded on secondary markets like NSE and BSE.

• Interest Rate: 2.5% per annum
• Minimum Investment: 1 gram of gold, corresponding to Rs 5,091 for Sovereign Gold Bond Scheme (Series I)
• Purchase Locations: Offline at nationalised banks and designated post offices, online at scheduled commercial banks and brokers’ websites. Online purchase gets a discount of Rs 50 per gram.
• Payment Mode: Cash up to Rs 20,000, Cheque, DD, Electronic Banking
• Tax Benefits: No capital gains tax if bonds are redeemed through RBI at maturity

Benefits of Sovereign Gold Bonds

1. Low Risk: Since these bonds are government-backed, the risk of default is shallow. The only risk in SGBs is the market volatility of gold.
2. Convenience: SGBs eliminate the need for physical storage and the risks associated with it. As a digital asset, it’s a secure and maintenance-free way to invest in gold.
3. Capital Appreciation – Tax-Free: Capital appreciation in SGBs is tax-free. Since gold is in consistent demand, the risk of significant fluctuations in its price is low.
4. Hedging Against Inflation: Gold prices rise during high inflation periods, so SGBs are a good hedge against inflation.
5. Indexation Benefit: Investors can avail indexation benefit for long-term capital gains on SGBs which helps to adjust the investment value for inflation.
6. Ease of Trading: SGBs held in dematerialised form can be traded on stock exchanges, though trading volumes may be low.
7. Loan Facility: SGBs can be used as collateral for loans; RBI has set a Loan to Value (LTV) ratio of 75% of the market value of the bonds.

Disadvantages of Sovereign Gold Bonds

1. Long Holding Period: The bonds have a long tenure of 8 years, which may not be suitable for all investors. Early redemption is available only after 5 years.
2. Capital Loss: SGB value is linked to international gold prices, so there is a risk of capital loss if the redemption value is lower than the purchase price. But long-term holding reduces this risk.
3. Liquidity: SGBs are less liquid than physical gold due to a 5-year lock-in period and low trading volume on stock exchanges.

Why RBI Issued Sovereign Gold Bonds?

India imports a considerable amount of gold to meet the demand in the market which affects the macroeconomic fundamentals and import bill of the country. RBI introduced SGBs to reduce the demand for physical gold imports by providing an alternative investment option. SGBs allow investment in gold in paper or digital form with a redemption price of INR based on the average cost of 999 purity gold.

Should I Invest in Sovereign Gold Bonds?

Whether to invest in SGBs depends on your investment goals and risk appetite. SGBs are relatively safe, but their value can fluctuate with the price of gold. They offer guaranteed returns and tax savings, so if you think gold prices will rise, SGBs are an excellent option. SGBs are long-term investments that provide portfolio diversification, capital appreciation, and periodic interest earning.

Summary

SGBs are a secure and convenient way to invest in gold without the hassles of physical gold. It offers fixed interest, potential capital appreciation, and tax benefits. Though there are risks, research and understanding of the market can help to minimise them. Investing in SGBs is a good option for low-risk, long-term investments.