Investment can indeed be a powerful way to grow our savings and wealth over time and Investing on the government issued bonds and securities are often considered as a relatively safe and stable options.
The SGB scheme introduced by RBI on the behalf of government is a unique financial instrument that allows investors to participate in the gold market without holding physical gold. Under this scheme, RBI issues bonds linked to market price of gold with specified interest rates and Investors have to pay the issue price at the time of subscription, receiving the periodical interest and market value of gold at the time of maturity.
HOW GOVERNMENT BENEFITS
Government issues bonds and securities as a means to raise funds for various purposes like budgetary gaps, public expenditure, monetary policy, financial management etc. and SGB is one of the kind. SGBs, in particular, other than these purposes benefits the government in several ways like gold monetization, gold market development, reduction in gold imports resulting in reduction in capital outflow, domestic financing and so on.
LIABILITY/COST FOR THE GOVERNMENT
The liability for the government primarily involves fulfilling its commitments to the investors in terms of issuance cost, payment of periodical interest, repayment of principal linked to market value of gold and capital preservation guarantee in case of reduction of market value.
Let us take a practical illustration on how much cost the government of India is bearing on one unit SGB 2015-16 issued back in February 2016 which are maturing in February 2024.
Refer Appendix 1:
Issue price = Rs.2684
Issue Cost = 1% (assumed)
Maturity Period = 8 years
Interest rate = 2.75% p.a. payable half yearly (Rs.73.8 p.a. to be paid Rs.36.9 half yearly)
Redemption price = Rs.6000 (based on current market price assumption)
Discounting rate = 7 % p.a
So based on above parameters, appreciation on the Net Proceed and cost to the government would be 10.4 % and 12% respectively and there will be net cash outflow of Rs. 2,166 by the government based on maturity date prices.
IS IT FINANCIALLY BENEFICIAL??
Though benefits to the government depend on its specific needs and the strategic objectives associated with funding, let’s glance it through the actual financial perspective comparing with other similar securities issued by the government.
Normally government also issues securities like Treasury Bills, Treasury Bonds, Zero Coupon bonds etc for the same aforementioned purposes. Assume T-Bills having below similar parameters.
Refer Appendix 2:
Issue price = Rs.2684
Issue Cost = 1% (assumed)
Maturity Period = 8 years
Interest rate = 7% p.a. payable half yearly (Rs.187.8 p.a. to be paid Rs.93.9 half yearly)
Redemption price = Rs.2684 (assumed to be redeemed in issue price)
Discounting rate = 7 % p.a
So for this T-Bills, government would be having a cost of 7.1 %.
On comparative financial analysis based on cost to be borne by the government, it could be seen that government is incurring loss while issuing the SGB (12 % cost) as against T-Bills (7.1% cost). This is mainly due to the fluctuating gold prices over the span of SGB. Since the prices have gone adversely up till the maturity of the SGB, it has resulted in the high cost to the government at maturity. However, government has not considered the hedging option which could cap the redemption price and hence the cost to the government would be limited to the set cap.
WHAT IF HEDGING OPTED
Let’s take the same illustration as taken for SGB but with hedging by the government at Rs. 4500 (assumed). So this hedging would cap the maximum redemption cost to the government to 4500 but investors will be redeemed based on the prevailing market rate.
Refer Appendix 3:
Issue price = Rs.2684
Issue Cost = 1% (assumed)
Maturity Period = 8 years
Interest rate = 2.75% p.a. payable half yearly (Rs.73.8 p.a. to be paid Rs.36.9 half yearly)
Redemption price = Rs.6000 (based on current market price assumption)
Redemption cost to the government after hedging = Rs 4500 (assumed)
Discounting rate = 7 % p.a
So, this will result on the appreciation on the Net Proceed and cost to the government as 6.7 % and 8.8% respectively and there will be net cash outflow of Rs. 666 by the government based on maturity date prices. Thus it can be concluded that, had the SGB 2015-16 scheme been hedged, government would have saved Rs 1500 (2166-666) on each unit but the government is losing its funds currently by not hedging the redemption price linked to the gold prevailing market prices.
In conclusion, government should make the balanced analysis of both the financial and non-financial factors while issuing the schemes like SGBs to ensure the effectiveness, sustainability and financial victory of such initiatives.
SGB Scheme Working Document:
