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Budget 2024: Should you still invest in SGB after Gold import duty cut?

This article discusses the impact on investors’ psyche due to impact on Gold price due to government policy change.

Budget 2024: Should you still invest in SGB after Gold import duty cut?


Posted on 28 Jul 2024
Author: Sayan Sircar
Tags: Tags Gold ;  Budget
14 mins read
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This article discusses the impact on investors’ psyche due to impact on Gold price due to government policy change.

Budget 2024: Should you still invest in SGB after Gold import duty cut?

This article is a part of our detailed article series on Union Budget 2024. Ensure you have read the other parts here:

📚 Topics covered:

What did change about the gold price?

cut the import duty on gold from 15% to 6%. This was a surprise to the gold market in India, where gold prices fell by 5% (as measured by 999 purity prices from the IBJA site) on 23rd July 2024, the date of the Budget speech. In this article, we will explore the impact of the duty cut on Sovereign Gold Bond (SGB) investors. But before going into SGB, let us quickly understand how gold prices work in India.

A short but complete history of gold prices in India since the 1950s

Gold price per 10 grams in India since 1950s

Gold prices in India change due to these factors:

  • Domestic demand for the yellow metal, mainly for jewellery and as a store of wealth (e.g. Streedhan)
  • International price changes of gold due to industrial demand, geopolitical factors like wars and pandemics like COVID
  • Change in the value of the rupee vs. foreign currencies like the US Dollar

Related:
A complete history of gold prices in India since the 1950s

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What was the immediate impact of the gold duty cut due to ?

One more factor that is not usually considered in understanding how gold prices move in India is the import duty. Given the massive demand for gold in the country, the government likes to tax imports. $100 of gold imported into the country was costing $115 due to the 15% import duty before . Now, immediately after the Budget speech, the effective price was reduced to $106.

The gold market reacted like this:

Date Gold in ₹/10gm Gold in $/oz. SGB Feb 2032 per share
Fri 26-Jul-24 68,131 2,385.57 7,708.28
Thu 25-Jul-24 68,227 2,364.50 7,722.25
Wed 24-Jul-24 69,151 2,397.59 7,871.82
Tue 23-Jul-24 69,602 2,409.21 7,925.11
Mon 22-Jul-24 73,218 2,397.65 8,096.42

On Tuesday 23rd July, the gold market, which is measured by the 999 purity 10 gram price from the IBJA website, fell from ₹73,218 to ₹69,602, a 4.94% fall. This has rattled a lot of SGB investors. We now explore why.

Also read
Which are the best and worst ETFs of India in Feb-2024?

What is the return expected from SGB?

As we have covered in our detailed FAQs on the concept of SGB, an SGB is a promise made by the Government of India to:

  • Sell one unit to the investor at the current gold price around the date of issuance
  • Give 1.25% (taxable) interest every six months on the amount invested by the investor
  • After eight years, give back money equal to the price of gold around the date of maturity

The last sentence is significant. Let us examine it again:

After eight years, give back money equal to the price of gold around the date of maturity

What is the risk here since the government guarantees to return money? The question here, which is implied in the definition of SGB, is this:

  • The government does not guarantee to return the invested amount
  • The government guarantees to return the amount equal to the price of gold around the maturity date

If you think in financial risk terms:

  • Credit risk: getting your money back
  • Market risk: not knowing in advance how much money you will get back

SGB has no credit risk (since the government guarantees that you will get back money) but has complete exposure to the market risk of gold price movement.

If the gold price goes up, like it has been going up recently, then nobody complains. But this customs duty cut, which caused a 5% gold price fall, suddenly acted as a wake-up call to SGB investors that:

The S in SGB is Sovereign

This means that the Government has at least partial control over gold price movements. Given that the 2026 Series II SGBAUG24 is due for maturity in August, those investors will be hit the most since there is little chance for gold prices to recover. The one after that, the 2026 Series II SGBSEP24, is another month away from maturity.

What is the change in gold prices in the first week since the announcement of ?

Date Gold in ₹/10gm Gold in $/oz. SGB Feb 2032 per share ₹ vs $ gold price SGB vs $ gold price
Fri 26-Jul-24 -0.14% 0.89% -0.18% -1.03% -1.07%
Thu 25-Jul-24 -1.34% -1.38% -1.90% 0.04% -0.52%
Wed 24-Jul-24 -0.65% -0.48% -0.67% -0.17% -0.19%
Tue 23-Jul-24 -4.94% 0.48% -2.12% -5.42% -2.60%
Mon 22-Jul-24 -0.03% -0.13% 0.01% 0.10% 0.14%

We will now calculate the change in SGB prices that are closest to maturity at this point due to the duty change for the gold price on 26-Jul vs. 22-Jul. The gold price change from Monday 22-Jul to Friday 26-Jul is this:

Gold price Since budget day
Gold in ₹ -6.95%
Gold in $ -0.50%
SGB Feb 2032 -4.79%

As an effect of this gold price fall, taking the approximate 5% fall of 23rd July 2024, the SGB issued on 5-Aug-2016 has now matured at a headline return of 122% instead of a possible 134%. Read more on this here: SGB issued in Aug 2016 has given 122% return in 8 years. How does that compare with FDs and equity mutual funds?

Related:
Which SGB series should you buy based on the highest discount?

What should SGB investors do now if the maturity amount of SGB can be altered by the government?

To answer this question, we need to understand what is the purpose of investing in SGB.

We have long maintained that SGB is an excellent way to buy gold in the future. This view is due to the fact that when you invest in SGB, on the issuance date, you pay the price of 1 gram of gold. When the SGB matures after 8 years, the government gives you back exactly the same amount of money equal to 1 gram of gold at the maturity time. To sweeten the deal further, the government gives 2.5% interest and does not make you pay any tax on the maturity amount.

Therefore, effectively, you bought a piece of (virtual) paper that behaved exactly like one gram of gold. So your investment, if you think of it as a paper form of gold, stayed exactly equal to one gram of gold before, during and after maturity.

Related:
What is the best way to accumulate gold for your child's wedding?

However, if the purpose of investing in SGB is to get returns from the gold price, then this would cause some heartburn since your potential returns have slightly fallen. It is therefore important to understand that when you invest in SGB:

  • Did you think of returns from the gold price? Then SGB is not the right product. Gold price movement is highly unpredictable and does not beat stocks for long periods.
  • Did you think of holding gold in a virtual manner? Then SGB is the best option vs. all other forms of gold.
  • Did you think of diversifying your portfolio via SGB? Then multi-asset funds with tax-free rebalancing between equity, bond, and gold are the better option.

In the end, there is one more point that we need to mention here. Every investment has multiple criteria for checking suitability:

  • Return (R) = gold price movement
  • Risk (R) = gold price fluctuations
  • Time horizon (T) = 8 years
  • Taxes (T) = none on the maturity amount, 2.5% interest is taxable at slab
  • Legal / regulatory (L) = government promises to give back the gold price value
  • Liquidity (L) = via stock market
  • Unique situations (U) = government can cut the gold price duty as described here: RRTTLLU: check these when choosing products for investing

Therefore, the duty cut is a classic example of either Unique situations (or alternatively Regulatory risk). The same risk is applicable to all government-linked schemes like EPF, PPF and NPS also. Ultimately, investors should re-examine their motivation to invest in SGB and proceed on that basis.

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This post titled Budget 2024: Should you still invest in SGB after Gold import duty cut? first appeared on 28 Jul 2024 at https://arthgyaan.com


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