Gold sovereign bonds to carry 1.5-3% interest rate

Government is considering interest rate lower than savings bank deposit for sovereign gold bonds which was announced yesterday in the union budget for 15-16.

According to highly placed sources, “interest rates on such bonds could be as low as 1.5 to 2% but the attractive part of that it will ensure returns in gold price apart from the interest rates because on the redemption, investor will be paid back amount equivalent to the gold price on the day of redemption.
Read our full coverage on Union Budget

However, returns in gold monetisation scheme could be higher at 3%.

The highly placed source quoted earlier also said that, “government is targeting those who are investing in gold by purchasing gold coins or bars.”

He also said that, government research shows every year investors buy gold worth 350 tonnes in form of gold coins and bars. These investment can be channelised in sovereign bonds which is a financial instrument. Government is not eyeing those who are buying jewellery for consumption.

This could be a better alternative than gold Exchange Traded Funds where fund house deduct their permissible expenses from the invested funds and they buy equivalent gold and store it in a vault by paying charges.  According to reliable source, in sovereign gold bonds, investment will be in bonds as per prevailing price of the gold.

The price will be denominated in grams and the scheme is likely to be operated through designated banks like the State Bank of India. However, banks operating gold will not have to buy actual gold under this scheme which means investors will get gold returns but no need to import gold.

Investors will get an annual return of 1.5 to 2% and at the maturity or redemption time he will be paid money as per prevailing price of gold at the time of redemption. Gold price will be those prevailing in India or in international market could not be ascertained.

However, according to the note earlier prepared by the government revenue agency, investments in such bonds should be offered tax concessions like exemption or relaxation in capital gain. It was also proposed to devise scheme for longer maturity for girl child with attractive tax incentives.

The sovereign bonds may look good as it gives gold price benefits as well as additional return. However there is a catch for banks through whom the bonds will be marketed.

If there is unusual increase in price of gold which is not unlikely, in that case repayment burden increases. In such case, if government accepts the recommendations of one of its agency that banks will have to hedge gold price risk.

The department under ministry of finance had proposed several hedging options which include interest rate spread on gold deposits, gold buying-selling rate spread, permitting banks to import part of the gold sold through bonds and keep that in lieu of SLR/CRR or even exempts such bonds from such reserve ratio provisions and there could be insurance to stimulate banks from excessive price escalation of gold or straight forward buying gold options in international markets.