Bonds that glitter like gold

After coming out with guidelines for gold deposit scheme the government on Friday released draft norms for gold bonds with a sovereign guarantee that would carry a minimum interest rate of 2 per cent, as it attempts to prune the estimated 300 tonne of bars and coins purchased by citizens every year.

The bullion-linked bond, however, would attract capital gain tax as in the case of physical form of gold. The government aims to issue bonds worth Rs 13,500 crore ($2.12 billion) or the equivalent of 50 tonnes of gold in the first year.

While retail investors often use the gold deposit schemes run by local jewellers and thus run a counter-party risk, in the proposed sovereign gold bonds (SGBs) the counter-party would be the Government of India.

The bonds would be issued in denominations of 2, 5, 10 grams of gold or other denominations. The tenor of the bond could be for a minimum of five to seven years so that it would protect investors from medium term volatility in gold prices. Also, KYC norms are proposed to be the same as for gold.

As per draft guidelines, SGBs will be issued in lieu of money, linked to the price of gold and issued by the RBI on behalf of the government. Banks, non-bank financial companies and post offices will be able to collect money and redeem bonds

SGBs will be restricted to resident Indians with an annual cap of 500 grams per person. The rate of interest will be linked to the international rate for gold borrowing but with 2 per cent as the indicative lower limit. Interest rates will be paid in terms of grams of gold.

On maturity, the investor will receive an amount, which is equivalent to the face value of the gold in rupee terms. Capital gains tax treatment will be the same as for physical gold. If it is held for more than three years, it will be termed a long-term capital gain and taxed at 20 per cent with indexation. If it is held for less than three years, then it will be taxed as income.

The bonds can be used as collateral for loans. The loan-to-value ratio may be set equal to ordinary gold loan mandated by the Reserve Bank of India.

Faced with high current account deficit and weak rupee, the government had come up with two schemes to reduce imports of gold, which is the second biggest contributor to import bill after oil Gold monetisation scheme and sovereign gold bonds are the two schemes. While the draft guidelines for the former were issued in May, the government late Thursday night issued draft guidelines for the SGB.

Comments are invited on draft SGB issue by July 2. The country consumes nearly 1,000 tonnes of gold every year, most of it imported.

Experts say this could be an attractive proposition that addresses pure investment demand for the precious metal and potentially result in savings of USD 2 billion on such imports.

“Unlike the GMS, where the primary objective is to ‘monetise’ India’s massive stock of physical gold, the SGBs scheme intends to convert the investment demand for physical gold into paper demand. In 2014, total investment demand for gold moderated to 180 tonnes from an average annual demand of 345 tonnes from 2010 to 2013. Hence, if the scheme is fully subscribed in the first year, then it will represent 27 per cent of the 2014 investment demand and would result in a saving of $2 billion on gold imports at current gold prices,” said Nomura economists Sonal Varma and Neha Saraf.

Ind-Ra said: “Gold sovereign bonds may triumph over other comparable products in the market such as gold exchange traded funds, physical bars and can lead to a reduction in India’s current account deficit.