Govt plans gold bonds to curb demand

Investors will soon be able to buy gold, albeit in the paper form, that will come with a sovereign guarantee, and earn interest on it as well. After announcing a gold monetization scheme, the government has released the draft outline for the sovereign gold bonds (SGBs) scheme, which would offer interest rates in terms of grams of gold.

The bonds will be issued in denominations of two, five and 10 grams of gold or other denominations with a minimum tenor of five-seven years. The rate of interest will be linked to the international rate for gold borrowing, but would have 2% as the indicative lower limit.

On maturity, the investor will receive an amount which is equivalent to the face value of the gold prevailing at the time in rupee terms. SGBs will be restricted to resident Indians with an annual cap of 500 grams per person.

These bonds will be issued on behalf of the Union government by the Reserve Bank of India (RBI) on payment of money and will be linked to the price of gold.

Banks, non-banking financial companies (NBFCs) and post offices will be able to collect money and redeem bonds on behalf of the government. SGBs will have a sovereign guarantee and can be used as collateral for loans. The loan-to-value ratio would be the same as that of gold loan mandated by RBI. The bonds could be easily sold and traded on commodity exchanges, the draft stated.

Capitals gains tax treatment will be the same for SGBs as for physical gold. If the bond is redeemed after three years, it will be termed a long-term capital gain and taxed at 20% with indexation. If it is held for less than three years, then it will be taxed as income.

Under the scheme, the government would bear the risk of gold price movement on issuances and exchange rate risks. Initially, it is not planning to hedge against these risks. Upside gains and downside risks on subsequent gold price movements, however, will remain with the investor.

The government intends to cap the amount raised through SGBs to 50 tonne (Rs 13,500 crore, or $2 billion, or 0.1% of GDP at current prices) in the first year. “If the scheme is fully subscribed in the first year, then it will represent 27% of the 2014 investment demand and would result in a saving of $2 billion on gold imports at current gold prices,” according to Sonal Varma and Neha Saraf of Nomura India.