How rising gold prices have made India’s sovereign gold bond scheme a liability, ET BFSI

India’s Sovereign Gold Bond (SGB) scheme, launched in 2015, was designed to scale back the nation’s dependence on bodily gold imports and provide traders a safe, interest-earning different. Nonetheless, a pointy and sustained rise in gold prices has turned the scheme right into a monetary burden for the federal government.

What was initially anticipated to be an economical borrowing mechanism has now resulted in vital liabilities, with the federal government going through the prospect of redeeming bonds at costs far greater than anticipated. This explainer delves into how the SGB scheme unfolded, the miscalculations that led to its escalating prices, and the teachings learnt.

What’s the major goal behind India’s Sovereign Gold Bond (SGB) scheme?

The federal government launched the SGB scheme in 2015 to scale back India’s dependence on bodily gold imports by encouraging traders to shift to digital gold. This was anticipated to decrease the gold import invoice and scale back the current account deficit. Moreover, the scheme aimed to offer traders with a secure and profitable different, providing a 2.5 % annual curiosity on their deposits.

Why did the federal government assume that the SGB scheme can be useful?

The federal government believed that since gold costs had stabilised after declining from their peak in 2011, issuing bonds linked to gold costs would permit the federal government to borrow cheaply. If gold costs remained comparatively secure or elevated reasonably, the price of redeeming the bonds can be decrease than the curiosity the federal government sometimes paid on common debt.

What went mistaken with this assumption?

The important thing misstep was the federal government’s failure to anticipate the continual rise in gold costs. When the SGBs have been first issued in November 2015, gold was priced between $1,100 and $1,200 per ounce. Since then, costs have steadily risen and now exceed $3,000 per ounce. This dramatic enhance has considerably raised the redemption price of SGBs, making them far costlier than initially anticipated.

Why didn’t the federal government hedge its publicity to rising gold costs?

To maintain the scheme enticing, the federal government selected to not purchase bodily gold because the underlying asset. Officers assumed that gold costs would stay secure and did not hedge the federal government’s publicity by taking positions within the worldwide futures market. Consequently, as gold costs surged, the federal government discovered itself unprotected in opposition to the worth danger, resulting in substantial liabilities.

How a lot legal responsibility does the federal government face because of the rising gold costs?

Between the scheme’s inception in 2015 and the ultimate issuance in February 2024, Rs 72,000 crore price of SGBs have been issued. These bonds collectively signify 132,000 kg of gold. With gold costs now hovering round Rs 91,000 per 10 grams, the redemption worth has swelled to Rs 1.20 lakh crore, inserting a major monetary burden on the federal government.

Why are SGBs thought-about a pricey type of borrowing?

SGBs have turned out to be an costly borrowing mechanism as a result of the bonds promise a return primarily based on the prevailing gold value on the time of redemption. With gold costs greater than doubling because the bonds have been issued, the federal government now has to pay traders at a lot greater charges than it initially anticipated. Including to the burden, SGBs provide a 2.5 % rate of interest and are exempt from capital gains tax upon redemption, additional eroding the federal government’s potential income.

How does the price of SGBs evaluate to common authorities debt?

Initially, the federal government believed SGBs can be a less expensive borrowing choice than common authorities bonds, which carried a near-8 % yield. Nonetheless, with gold costs greater than doubling, the efficient price of SGBs has change into considerably greater than that of conventional authorities borrowing.

Did the SGB scheme reach decreasing gold imports?

Regardless of the scheme’s intent to curb gold imports, India’s urge for food for bodily gold has remained sturdy. Annual gold imports have averaged $37 billion over the previous decade, even after the introduction of SGBs. In a bid to discourage gold purchases, the federal government raised customs duties to fifteen % in 2022, however this solely led to a surge in gold smuggling.

Why did the federal government proceed issuing SGBs regardless of rising gold costs?

The federal government saved issuing new collection of SGBs whilst gold costs surged, with out addressing the inherent value danger. This failure to pause or restructure the scheme earlier has compounded the monetary legal responsibility. It was solely in February 2024 that the federal government lastly determined to halt new issuances.

Why are SGBs being described as a ‘bare brief place’ for the federal government?

In monetary phrases, a unadorned brief place means taking over a danger with none underlying safety. Because the authorities didn’t hedge its publicity to rising gold costs and issued bonds tied to the worth of gold, it successfully created a large-scale bare brief place. As gold costs soared, the federal government was left susceptible, with taxpayers now bearing the burden of those rising prices.

What classes will be discovered from the SGB expertise?

The SGB scheme demonstrates the hazard of constructing long-term monetary commitments primarily based on optimistic assumptions with out correct danger administration. Hedging in opposition to value fluctuations and designing monetary merchandise with built-in safeguards might have prevented the SGBs from changing into such a pricey legal responsibility. The choice to pause new issuances is a step in the best path, but it surely comes after years of mounting monetary pressure.