The Sovereign Gold Bond (SGB) scheme, initiated by the Government of India, is currently under scrutiny. The government is contemplating its discontinuation due to rising costs associated with financing the fiscal deficit. This comes after the recent Budget 2024-25 announcement, which included cut in gold import duty aimed at stimulating gold demand.
What Are Sovereign Gold Bonds?
Sovereign Gold Bonds are debt securities issued by the Reserve Bank of India (RBI) on behalf of the government. Each bond unit represents one gram of gold. The scheme allows investors to buy gold in a non-physical form, offering a fixed interest rate of 2.5% per annum on the initial investment. The bonds can be traded in the secondary market, providing liquidity. Upon maturity, investors receive the market price of gold in Indian rupees, based on the average closing price over the previous three business days.
Benefits of Sovereign Gold Bonds
SGBs are designed to be a safer alternative to holding physical gold. They eliminate risks associated with storage and theft. Investors benefit from regular interest payments, which are credited semi-annually. The final redemption amount is linked to the market value of gold, ensuring that the investor’s capital is protected.
Concerns About the Scheme
Despite the benefits, the government is concerned about the high cost of financing the fiscal deficit through SGBs. The number of bond tranches has decreased , indicating a shift in strategy. The customs duty reduction on gold has also contributed to increased demand for gold, further questioning the necessity of the scheme.
Recent Developments
The fiscal year 2024-25 has seen a reduction in SGB issuances. The government has cut the gross issuances from Rs 29,638 crore to Rs 18,500 crore. No new SGBs have been issued this financial year, reflecting a strategic pivot. The RBI has announced a window for premature redemption of certain bonds, allowing investors flexibility.
Performance of Past Bonds
Past SGBs have shown appreciation. For instance, bonds issued in 2016-17 appreciated from Rs 3,119 to Rs 6,938 upon redemption, alongside accrued interest. Similarly, Series II bonds provided a return of 126.4% over the eight-year holding period, demonstrating the potential profitability of the scheme.
Future of Sovereign Gold Bonds
The future of the SGB scheme remains uncertain. With increasing costs and changing market dynamics, the government must weigh the benefits against the financial implications. The focus on boosting gold demand through import duty cuts may further influence the decision regarding the continuation of the scheme.
Questions for UPSC:
- Critically examine the impact of the Sovereign Gold Bond scheme on India’s fiscal health and gold market.
- Discuss in the light of recent government policies, how does the reduction of customs duty on gold affect domestic gold prices and demand?
- Explain the concept of fiscal deficit. What are the main instruments used by the Government of India to finance it?
- With suitable examples, discuss the advantages and disadvantages of investing in gold as a financial asset compared to traditional investment options.
Answer Hints:
1. Critically examine the impact of the Sovereign Gold Bond scheme on India’s fiscal health and gold market.
- SGBs provide the government with an alternative financing mechanism, reducing reliance on traditional borrowing methods.
- The fixed interest rate of 2.5% offers investors a stable return, potentially increasing gold investment.
- However, high financing costs associated with SGBs raise concerns about their sustainability in managing fiscal deficits.
- The reduction in SGB issuances indicates a shift in government strategy towards managing fiscal health.
- Increased demand for gold due to customs duty cuts may lessen the relevance of SGBs as a gold investment vehicle.
2. Discuss in the light of recent government policies, how does the reduction of customs duty on gold affect domestic gold prices and demand?
- The reduction of customs duty from 15% to 6% lowers the cost of imported gold, making it more affordable.
- Lower prices typically stimulate demand, leading to increased purchases of gold in both physical and investment forms.
- This policy aims to curb the black market and promote legitimate gold trading within the economy.
- Higher demand can lead to fluctuations in domestic gold prices, influenced by global market trends.
- Overall, the duty cut aligns with the government’s objective to boost investment in gold, impacting market dynamics .
3. Explain the concept of fiscal deficit. What are the main instruments used by the Government of India to finance it?
- Fiscal deficit occurs when a government’s total expenditures exceed its total revenues, excluding borrowings.
- It indicates the extent to which a government is financing its operations through debt.
- Main instruments for financing fiscal deficit in India include dated securities, treasury bills, and the National Small Savings Fund (NSSF).
- Sovereign Gold Bonds (SGBs) are also utilized as a financing tool, providing an alternative investment option for the public.
- Effective management of fiscal deficit is crucial for maintaining economic stability and investor confidence.
4. With suitable examples, discuss the advantages and disadvantages of investing in gold as a financial asset compared to traditional investment options.
- Advantages of gold include its status as a hedge against inflation and currency fluctuations, preserving wealth over time.
- Gold investments, such as SGBs, offer liquidity and regular interest payments, unlike physical gold which incurs storage costs.
- However, gold does not generate passive income like stocks or bonds, which provide dividends and interest.
- Market volatility can affect gold prices, making it a riskier investment during economic downturns compared to stable assets like government bonds.
- Investors may face higher transaction costs when buying or selling physical gold, making it less cost-effective than traditional investment options.
