Covid-19 crisis far from over with the second wave setting in
The Covid-19 crisis is far from over, more so with the second wave setting in. Apart from the pandemic, there's Brexit and a battered global economy, which will try to find new, socially distanced ways to do business. Uncertainty is guaranteed for the next couple of years at least. Fears of a global recession and easy liquidity by central banks across the world have increased the attractiveness of gold as an asset class.
Besides, gold is a good hedge against rupee weakness. International prices are dollar-denominated. If the rupee weakens, that factors automatically into the gold price. Also, gold tends to keep pace with, or outpace inflation. India's pattern of low growth and rising inflation could in itself set up a bull-run since India aggregates to a substantial player in the global gold market. Financial planners believe one of the best ways for investors to capture this asset class is through sovereign gold bonds, and investors looking to build allocation could add small amounts in each tranche offered by the government.
India government has introduced two important schemes, the Gold Monetisation Scheme and the Sovereign Gold Bond Scheme (SGBS), which are expected to positively impact the economy. Mind you that despite being among the largest gold market with an average demand of around 800 tonne in a year which accounts for around 25 per cent of the world's gold demand, India's domestic production of gold is minimal. Consequently, the demand is met largely through imports. This large demand on gold imports has an adverse impact on the current account deficit CAD) and further implications on the external sector stability. A Current Account Deficit (CAD) is a country's measurement of trade, which means that the import of trade and services is greater than the value of exported products. To put it simply, CAD widens when imports grow much faster than the exports.
SGBS had been introduced in the Union Budget of 2015-2016 to promote digital gold as an alternative to purchasing physical gold. One has to pay the issue price in cash and the bonds will be redeemed in cash on maturity. The price of the bonds, issued both in paper and Demat forms, is fixed on the basis of prevailing price of gold. The investment is for a period of eight years with an option of premature withdrawal from the fifth year onwards. One also has the option of rolling over the bond for a further period of three years, if the price of gold is low. The SGBS has also been made eligible to be traded on exchanges and can also be used as collateral for loans. Additionally, one is exempted from capital gains tax arising on redemption of SGBS. One receives the existing market price at the time of redemption of bonds along with interest. It is better than holding gold in physical form as the risks and costs of storage and security are eliminated. This form of 'paper gold' is free from costs like making charges or issues like purity of gold in jewellery form. You can easily invest in this scheme after completing the KYC process. If one holds these bonds in demat format, then these can be traded in stock exchanges. If one wants to use it as collateral for loans, then the loan to value ratio is the same as applicable to ordinary gold loan.
The SBGS has an up to eight-year maturity period, with redemption allowed after five years. It offers interest unlike the physical metal and it's dematerialised, which takes care of storage. It has fair liquidity. The bonds are traded in the secondary market. However, this is usually at substantial discounts to the India Bullion and Jewellers Association Ltd. (IBJA) rates for .999 purity gold, which is underlying. Loans are readily available against the SBGS. The bond offers a 2.5 per cent interest calculated on the subscription price. This has interesting implications.
The SGBS aims to reduce people's dependence on physical gold as savings. As the bonds are similar to physical gold in terms of value and investments, the scheme would reduce imports. This again will bridge the CAD.