Capital Markets: Challenges and Developments

Sovereign Gold Bonds: A substitute for physical gold


From UPSC perspective, the following things are important :

Prelims level: Sovereign Gold Bonds

Mains level: Not Much

Gold bond prices rise to near record highs after the second tranche of subscription were closed.

Questions based on capital markets are quite frequent these years.  Consider this-

Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly? (CSP 2019)

(a) Certificate of Deposit

(b) Commercial Paper

(c) Promissory Note

(d) Participatory Note

What is a Sovereign Gold Bond (SGB)?

  • SGB is a substitute for holding physical gold.
  • The bonds are issued by the RBI on behalf of the government and are a bond denominated in gold.
  • The government issues such bonds in tranches at a fixed price that investors can buy through banks, post offices and also in the secondary markets through the stock exchange platform.

What are the benefits of buying SGB?

  • These bonds are backed by a sovereign guarantee and can also be held in Demat form.
  • Further, they are priced as per the underlying spot gold prices.
  • Hence, investors who want to invest in gold can buy the bonds without worrying about the safekeeping of physical gold along with locker charges, making charges or purity issues.
  • Plus, these bonds offer interest at the rate of 2.5% per annum on the principal investment amount.
  • While the interests on the bonds are taxable, the capital gains at the time of redemption are exempt from tax.
  • These bonds can also be used as collateral for availing loans from banks and NBFCs.

How are the bonds structured?

  • SGB has a fixed tenure of eight years, though early redemption is allowed after the fifth year from issuance.
  • Since the bonds are listed on the exchange, these can be transferred to other investors as well.
  • The bonds are priced in rupees based on the simple average of the closing price of gold of 999 purity which published by the India Bullion and Jewellers Association.
  • At the time of redemption, cash equivalent to the number of units multiplied by the then prevailing price would be credited to the bank account of the investor.

Are there any risks in investing in SGB?

  • A capital loss is a risk since the bond prices would reflect any change in gold prices.
  • If gold prices fall, the principal investment would fall proportionately.

Why need such bonds?

  • The gold demand rises in times of uncertainty or high inflation.
  • Gold demand is mostly met through imports
  • Years of high imports are ones of high current account deficits which, in turn, have weakened the rupee.
  • It is to reduce this huge import bill that, in November 2015, the government tried to introduce gold bonds.

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