The sovereign gold bond scheme may not continue; here’s why

SGBs on radar: The Indian government is rethinking its strategy of issuing new Sovereign Gold Bonds (SGBs) due to the increasing costs associated with financing the fiscal deficit through these instruments. Sources indicated that a final decision on whether to continue with fresh SGB issuances is expected by the end of September 2024.

Customs Duty Reduction Alters SGB Rationale
The government’s reconsideration follows the sharp reduction in customs duty on gold, as announced in the Union Budget 2024-25. The duty was slashed from 15 to 6 per cent, which undermines the original purpose of SGBs—discouraging physical gold holdings and reducing gold imports. The duty cut was intended to lower input costs, reduce gold smuggling, boost domestic manufacturing, and increase exports. However, it has also lessened the need for policies that aim to curb gold imports.

Rising Costs of SGBs
The Union Budget 2024-25 lowered the projected gross SGB issuances to Rs 18,500 crore, down from Rs 29,638 crore as planned in the interim budget earlier in February. Net borrowing through SGBs has also been reduced to Rs 15,000 crore from the previously estimated Rs 26,138 crore. In FY24, the Centre’s gross and net borrowings via SGBs stood at Rs 26,852 crore and Rs 25,352 crore, respectively.

“It is one of the most expensive instruments to fund the fiscal deficit,” an economist said. The cost of borrowing through SGBs is around 13.75 per cent for the Sovereign Gold Bond 2016-17 Series I, which is significantly higher than the 7-8 per cent through dated securities and up to 8.2 per cent through National Small Savings Fund (NSSF) schemes.

Investor Impact and Market Dynamics
The SGB 2016-17 Series I, initially issued at Rs 3,119 per gram with a 2.75 per cent annual interest rate, is due for redemption on August 5, 2024. Given the current gold price of Rs 7,190 per gram, investors are expected to see a compounded annual growth rate (CAGR) of 11 per cent, in addition to the annual interest. However, the customs duty cut has led to a decline in domestic gold prices from Rs 7,350 per gram to around Rs 6,900 per gram, which may lower investor returns.

“SGBs were intended as an investment tool to reduce gold imports. Now that the duty has been reduced, we need to reassess our approach,” an official remarked, adding that any future decisions will aim to balance the interests of both investors and the government.

The Future of SGB Issuances
Given the fiscal challenges and shifting economic landscape, the government will likely make a comprehensive decision on whether to continue with SGB issuances. According to experts, It is not a social security scheme. Suggesting that SGBs may no longer be the most viable option for financing the fiscal deficit.

In contrast, the government plans to move forward with issuing sovereign green bonds worth approximately Rs 20,000 crore this financial year, despite concerns about the limited greenium, or lower borrowing costs, which only offered a 1-2 basis point reduction last year.
As the government evaluates its options, the decision on new SGB issuances will be crucial for both the bond market and the broader fiscal strategy.