Sovereign Gold Bonds Scheme

Why in news?
The government spelt out the broad contours of a scheme involving the issue of sovereign gold bonds that is aimed at partly shifting the estimated 300 tonnes of physical gold bars purchased every year to the demat gold bond format.

What are Sovereign gold bonds?

These are bonds (in the form of a demat document) issued instead of the physical gold. So, it's like, if you want to buy 2g of gold, you go to the dealer (post office, brokers, etc.), give them the money (equivalent to 2 g of gold). They give you the bond and NOT gold.

What is the govt scheme like?

Source: The New Indian Express

Example: Let us say you invest in a 2 gram gold bond with tenure of 5 years by let us say investing Rs 2,500 / gram. Your investment of Rs 5,000 would fetch you say 2% interest per annum and on maturity you would get Rs 6,000 if the market price of gold on that date is Rs 3,000 per gram. The interest will be 2% on the then price of gold (at the time of maturity), i.e. 2% of ₹ 6000, ₹ 120.

The downside is you would get only Rs 4,000 if the market price of gold on that date is Rs 2,000 per gram. But then given the scarcity value of gold, one would optimistically hope for appreciation alone 

Advantages:

• Reduction in import bill of India.
• This India, the world's largest consumer of gold, imports around 800-900 tonnes of gold annually, the second-biggest item after oil. 
• A key benefit from gold bonds is that an investor will not have to be worried about the quality of gold which is generally a big hurdle when purchasing gold from jewellers. 
• This also makes it more fungible to be used as collateral by both lenders and buyers
• Better option than Gold Monetisation Scheme - 
•  gold monetization scheme notified last month, on the other hand, is messy, involving as it does melting of one’s jewelry which causes deep hurt to women folk.
• Provides investment choice to consumers and integrate gold further into regulated financial sector.
  

Critical Analysis:

• The upside gains and downside risks will have to be borne by the investor, who needs to be aware of the volatility in gold prices.
• Though the draft is blasé about the issue, the government might well incur a loss in operating the scheme because not only must it pay interest but also bear the redemption loss arising on two counts -- foreign exchange rate fluctuation and gold rate fluctuation. The two may feed on each other. 
• There is no reason why bonds should not be allowed to be held in physical form especially by those who are not interested in trading with them in the bourses but instead are focused on biding their time for maturity.
• The draft envisages investments in these bonds being made by entities which mean companies too would be eligible. 
• It is submitted they should be made out of bounds for companies and other forms of business organizations because otherwise companies would come to hijack the scheme like they did with capital gains bonds namely National Highway Authority of India (NHAI) bonds and Rural Electrification Corporation (REC) bonds and the government had to step in and limit per entity investment to Rs 50 lakh per annum.
• For individuals at whom the scheme must be directed, tax incentive must be given as a further sweetener. 
• This might act as a dampener to the other gold related scheme -  Gold Monetisation Scheme 

[Sources: First Post, Indian Express, Business Standard]