Sovereign Gold Bond

Also called: SGB · Topic: Financial Markets, Instruments, Insurance and Pensions · NCERT: Beyond NCERT

Meaning

A Sovereign Gold Bond (SGB) is a government security (G-sec) valued in grams of gold, not in rupees. The investor gets a fixed interest of 2.5% a year on the issue value, and at maturity is paid the market price of gold at that time. It was launched in November 2015.

It matters because it lets people hold gold "on paper". This was meant to cut imports of physical gold, which widen India's current account deficit (CAD). It also shows how a debt instrument can leave the government with a hidden, growing bill.

Formulas:

Annual interest per gram = 2.5% × issue price per gram
Redemption amount = number of grams × redemption price per gram

Explanation

How an SGB works

The unit is a gram of gold. The investor pays rupees at the issue price and is credited with that many grams of gold in bond form.
It is a G-sec. The buyer lends money to the Government of India, so there is practically no default risk. The government can raise taxes or create money to repay.
Interest is fixed: 2.5% a year on the issue value. It is not worked out on today's gold price.
Tenure is 8 years. Early exit is allowed after the 5th year, but only on a date when interest is due [1].
Redemption price:
It is the simple average of the closing price of 999-purity gold (99.9% pure gold) over the previous 3 business days [1].
The price is published by the India Bullion and Jewellers Association (IBJA) [1].
Tax: capital gains (the profit from the rise in price) are tax-free on redemption.

Worked example

An investor buys 10 grams at an issue price of ₹5,000 per gram and pays ₹50,000.
Interest: 2.5% of ₹5,000 = ₹125 a year per gram, so 10 grams earn ₹1,250 a year.
Redemption: suppose the IBJA-based redemption price is ₹7,231 per gram. (This was the actual price for redemption due on 30 April 2024 [1].)
Amount received = 10 × ₹7,231 = ₹72,310.
Gain = ₹72,310 − ₹50,000 = ₹22,310, which is tax-free on redemption.
Total return = fixed interest + rise in gold price. Physical gold gives only the second part.

Why the government likes it, and why it became costly

The benefit: fewer gold imports and a smaller CAD
People buy paper gold instead of bars and coins.
India imports less gold and spends fewer dollars abroad.
The CAD (the gap by which a country's payments abroad exceed its earnings from abroad) narrows.
The cost: the government carries the gold-price risk
The government borrows in rupees but must repay at whatever gold costs on the redemption date.
If gold prices rise sharply, the repayment grows far beyond the money it borrowed.
The extra cost is added on top of the 2.5% interest.
What decides the government's final cost:
Gold price at redemption: higher price means higher cost.
The rupee–dollar rate: a weaker rupee raises the rupee price of gold.
The number of investors who exit early after year 5.

In India

Issuer: the Government of India. As a G-sec, the SGB falls under the Government Securities Act 2006.
Manager: the RBI, which manages the Centre's debt by statute under the RBI Act 1934. The RBI announces redemption prices through press releases, e.g. ₹7,231 per unit for redemption due on 30 April 2024 [1].
Price benchmark: IBJA closing price of 999-purity gold, averaged over 3 business days [1].
Launch: November 2015, to reduce physical gold imports and ease the CAD.
Present status: no fresh tranche has been issued since February 2024. Gold prices rose sharply, so repaying investors became very costly for the government. Bonds that were already issued continue until they are redeemed.

Don't confuse with

Physical gold / gold ETF: these give only the gain from a rise in gold price. The SGB also pays 2.5% interest a year and is backed by the government. Buying an SGB does not bring any gold into India.
Gold Monetisation Scheme: under that scheme people deposit gold they already own with banks. With an SGB, people pay cash and get a bond valued in gold.
Inflation-indexed bond (IIB): an IIB protects the investor against inflation (CPI/WPI). An SGB follows the gold price, which can move very differently from inflation.
Ordinary dated G-sec: it repays a fixed rupee face value. An SGB repays a gold-linked amount that nobody knows in advance, so the government bears a price risk.

Prelims Hooks

SGB = G-sec denominated in grams of gold, launched November 2015. Aim: cut physical gold imports and the CAD.
Interest: 2.5% a year on the issue value, not on the current gold price. Example: ₹5,000 issue price gives ₹125 a year per gram.
Tenure: 8 years. Early exit only after the 5th year, on an interest date [1].
Redemption price = simple average of the IBJA 999-purity gold closing price over the previous 3 business days [1].
Capital gains on redemption are tax-free.
Trap: no fresh SGB tranche has been issued since February 2024. The government, not the investor, bears the gold-price risk.

Mains Points

A contingent liability that grew (a cost that depends on a future event, here the gold price):
Gold prices rose sharply, so the government owes far more than it borrowed.
Like oil bonds, the SGB shows how an instrument can postpone fiscal costs into later years.
This makes the case for transparent accounting and hedging of such liabilities.
External sector link:
The SGB tried to turn Indian households' demand for gold into financial saving. This eases the CAD and pressure on the rupee.
Stopping new issues takes away one tool for cutting gold imports. Policy must choose between a lower CAD and the fiscal risk.
Instrument design lesson:
Retail-friendly features (a sovereign guarantee, interest on top of gold returns, tax-free gains) brought in investors.
But passing the full price risk to the government made the scheme costly to keep running.
Future schemes need a better balance between what investors get and what the government bears.

Related concepts

The government securities market

Sources

1RBI Press Release — Premature redemption price under Sovereign Gold Bond Scheme (29 April 2024)rbidocs.rbi.org.in · tier 1