India the biggest consumer of gold in the entire world, where people consume gold either for personal consumption or for investing (bullions and gold bars) has found a way to reduce the demand of physical gold by launching a gold bond scheme in the country. According to this scheme bonds of different denomination will be issued by RBI on behalf of Indian government which will be backed by gold (in physical form purchased by RBI).
This scheme will be beneficial to people who buy gold only for the purpose of investing.These bonds offer the same benefits as physical gold in terms of return. Investors will earn interest on these bonds which will be linked to gold prices. Also investors don’t have to worry about holding gold in physical form.
Basic details need to know before investing:
The bonds will be denominated in rupee, as the purpose of government is to raise INR 150Bn from this scheme. Bonds will be issued in denomination equivalent of 5, 10, 20, 50,100 grams or in other denomination. These bonds will only be issued to Indian residents and entities and maximum allowable limit will be 500 grams per person per year which means that no individual or entity can buy bonds of value more than 500 grams in one year. These bonds will be available in both paper and dematerialized form. The tenure of bond will be for a period of 8 years with option to exit in 5th, 6th and 7th years to be exercised on interest payment dates. Anyone can buy or sell these bonds as they will be traded on exchanges at any time.
Chances of this scheme for being successful are quite high because this scheme comes with some factors which make it attractive to Indian households. Among many advantages, some of the good features are:
- Apart from having capital gains on such investment, one will earn coupon along the way. Coupon rate will be 2.75% per annum compounded semi-annually.
- If in need of money, holder of these bonds can go to any bank and ask for a loan by collateralizing these bonds at a loan to value (LTV) ratio permitted by RBI(maximum up to 75%).
- All the costs that will be borne by agency relating to distribution and sales commission will be reimbursed by the government.
- As bonds will be traded on exchanges they will offer liquidity by allowing exit at any time from 5th year to the bond holders.
- The risks and cost of storage will get eliminated.
Let’s take a practical example to better understand this concept:
Notes: 1. Coupon amt. is on Amount Invested.
On maturity or at time of redemption, the proceeds for bond holder will be equivalent to the prevailing market value of gold originally invested in Indian rupee. The redemption price will be based on simple average of previous week(Monday-Friday) price of closing gold price for 999 purity published by IBJA (Indian bullion and Jewellers Association Ltd.)
One would definitely think that there is already a way of investing in gold available to investors other than holding it in physical form, that is gold ETF. Why is there a need to launch a different scheme?
This is because gold ETF is a complete replica of gold commodity however it doesn’t give additional benefits apart from having capital gains. Moreover, in this sovereign gold bond scheme a person will be entitled to earn a coupon rate (2.75%p.a compounded semi-annually in this case) in addition of having capital gains. Also these bonds are backed by government of India which willensure a high level of safety.
Conclusion: Chances of this scheme to be a hit is quite high because at end Investors will find them in a win-win situation as returns will depend on two factors: Coupon payments and Gold prices at time of maturity. People invest in gold with a view of having high gold prices in future so if at time of maturity if a price reaches to their expectations then Sky is the limit in terms of return. If it go other way round (price don’t surge that much) then investor will still going to earn fixed rate of returns (coupon) on their money invested.
This blog is written by Jatin Aggarwal, Sem III student of MBA (FA), ICoFP Delhi Campus
