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Pros and Cons of Sovereign Gold bonds

The sovereign gold bonds promised by the Finance Minister Arun Jaitley in Budget 2015, have its own advantages and disadvantages in the gems and jewellery industry. Following are some of the key impact sovereign gold bond will have on the sector.

India is all set to introduce a sovereign gold bond as an alternative to physical gold after the concept of bonds was introduced in Budget 2015-16. The bonds will carry a fixed interest rate, and will be redeemable in cash pegged to the face value of gold at the time of maturity. Other than giving investors a long exposure to gold, it also provides the advantage of earning a fixed interest rate as gold typically has no direct yield.

Sovereign gold bonds to reduce gold imports

The finance minister in his Budget speech the accepted that reducing gold imports led to the unprecedented 30-plus year-high current account deficit of 4.7 per cent of GDP in FY13 with gold imports accounting for over 3 per cent of the deficit! According to reports, gold imports have surged again and the current account deficit for the latest quarter has increased to 2.1 per cent from 1.2 per cent of GDP. With this sombre background, Arun Jaitley, in his Budget speech, proposed sovereign gold bonds and monetisation of the existing domestic gold stocks estimated at over 20,000 tonne to reduce gold imports.

The proposed Sovereign Gold Bond Scheme is like a gold ETF (exchange traded fund) with the difference being that the ETF doesn’t pay any interest, but delivers gold returns to investors by investing the entire proceeds of subscription in metal gold which is held in demat form. Significantly, all the 14 gold ETFs in India, between them, hold no more than 40 to 50 tonnes of gold, which is a mere 5 per cent of annual gold imports of 800 to 1000 tonnes. So a gold ETF does not at all reduce metal gold demand and all it does is substitute gold demand from individual metal gold investors to the professionally managed gold ETF.

“Gold imports will go down by at least 25 percent, if the two policies are implemented. But the government must include jewellers too,” said Bachhraj Bamalwa, immediate past president of the All India Gems and Jewellery Trade Federation. Babu felt the schemes can attract up to 100 tonnes. Jayantilal Challani, President of The Madrass Jewellers & Diamonds Merchants’ Association is positive about the Sovereign Gold Bonds, he says, “It will impact the gold traffic in the country, which has been a concern for last two years. It will also reduce the illegal trafficking of gold as introducing bonds will be regulated by the official body and the bonds will be sold at post offices and banks to reach maximum retailers.”

Sovereign Gold Bonds to profit Indian economy

The sovereign gold bonds promised in the recent Budget speech will be made attractive to savers with the twin benefits of a likely price appreciation of the metal and a nominal interest rate of 1-2 per cent. As per an internal estimate of the finance ministry, anything between `20,000crore and `40,000 crore could be mobilised annually as financial savings through this new instrument. The mobilisation will correspondingly reduce the purchase of physical gold and, hence, imports of the yellow metal that almost singularly pushed up the country’s current account deficit to an uncomfortable 4.7 per cent of GDP in FY13.

The government, according to sources, is likely to issue these bonds with a shorter tenure of three, five and seven years to mitigate the price risks to either side and attract household financial savings, which as a percentage of GDP has declined in recent years. A cap is likely to be fixed on investments in these bonds to discourage institutional investors from participating in it, sources said. The exact contours of the scheme will be ready by May. Financial Express reports the sovereign gold bonds will be sold through post offices and banks to reach out to the maximum number of retail investors.

Rural buyers to face challenges

Since, two-thirds of India’s gold is consumed by rural areas, monetizing holdings or convert them into paper bonds is an alienated concept as rural crowd only understands physical possession of the precious metal. “Bonds will get comparatively faster acceptance among the urban investors, but the success of the bonds will also depend on the customer, the rural people,” K.A. Babu, head of retail business with Federal Bank, told IANS.

“The rural folk in India are believed to be in possession of 65 percent of physical gold in India, mostly in the form of jewels. They need to move out of the emotional view on gold and see it purely as a vehicle for investment,” Babu added. Suvankar Sen, Executive Director of Kolkata-based jeweller Senco Gold and Diamonds, was not sure about the actual impact. “The two new schemes will reduce imports. But the people in rural areas are not quite ready to part with the yellow metal,” Sen said. “Gold is a reflection of lifetime savings. I am not quite sure how they will connect to the schemes psychologically,” he told IANS — an assessment shared by Federal Bank’s Babu, who said the rural people also saw gold as something auspicious, easy to trade.

According to the All India Gems and Jewellery Trade Federation, another important factor that must be considered while introducing the two schemes will be to also include the jewellers, since they are the ones who deal directly with customers. “It will be easier for jewellers to convince the people to melt the yellow metal for investments and present a fair estimate of gold jewellery. Tie-ups with banks need to be made beforehand to implement the scheme through jewellers.” Bamalwa said.

While the government is set to experiment with sovereign gold bonds, it may be noted that another new product, (retail) inflation-indexed bonds, which it launched last year as an alternative to investments in gold, bombed. The retail inflation rate has dropped from 11.2 per cent in November 2013 to 4.28 per cent in December 2014 and inched up to 5.37 per cent in February 2015. G Jaya Acharya, President of Karnataka Jewellery Federation said, “Industry may suffer as introduction of bonds can add-on to the confusion about where to buy gold from. In addition to this, if Government agrees to give good interests, it can go against the gems and jewellery sector.”