Buy and hold investors, avoid high secondary market premiums on SGBs
Source: Business Standard
The Reserve Bank of India (RBI) typically issues Sovereign Gold Bonds (SGBs) in June and September each year. However, no tranches have been issued in 2024-25 (FY 2025). The last tranche of SGB Series IV (FY 2024) was issued in February. In the absence of fresh issuances, should you purchase SGBs from the secondary market, where they are trading at significant premiums?
Reasons for the pause
Since their launch in 2015, the RBI has issued 67 tranches of SGBs. Of these, four have matured. SGBs were introduced to reduce the import of physical gold and reduce the current account deficit.
A key reason for the current delay is that SGBs have become an expensive borrowing route for the government. If gold prices rise by, say, 5 per cent annually, and interest paid is 2.5 per cent, the borrowing cost for the government would be 7.5 per cent. However, the faster-than-expected rise in gold prices has increased the government’s liability.
“The issuance price of gold has more than doubled, rising 2.3 times since 2015,” says Deepesh Raghaw, a Securities and Exchange Board of India (Sebi)-registered investment adviser (RIA). The first tranche was priced at Rs 2,684 per gram and the latest at Rs 6,263 per gram.
Furthermore, the country’s foreign reserve position is comfortable. “The need to curtail the outflow of foreign reserves has reduced,” says Gnanasekar Thiagarajan, co-founder and chief executive officer (CEO), Commtrendz.
SGBs provide multiple benefits. “You get to buy at a transparent, wholesale price, often with a discount at the time of subscription. Buyers don’t have to pay for storage or insurance. Instead, they earn 2.5 per cent interest annually. Plus, no goods and services tax (GST) is levied,” says Bhargava Vaidya, proprietor, B N Vaidya & Associates.
Buy from secondary market?
SGBs traded at a discount for a long period, as frequent issuances from the RBI meant sellers in the secondary market needed to offer discounts to attract buyers. This made secondary market purchases attractive.
However, after February 2024 no new bonds have been issued, and SGBs have started trading at a premium. Many investors, convinced of the attractiveness of SGBs, are willing to buy them even at inflated prices. “While SGBs are a sound investment, they aren’t worth buying at any price. The interest income you earn from them will not justify paying a high premium,” says Raghaw.
When considering secondary market purchases, look at the residual tenure of the bond. The longer the remaining maturity, the more interest you will earn. Check the ‘ask’ price, and aim to buy bonds trading near their face value or the current price of gold.
If you wish to do a more exact calculation, Raghaw suggests carrying out the following exercise. The residual maturity, the face value, and the interest (and timing of payout) over the remaining life of the bond are known (the maturity value is not known). Put those interest cash flows on an excel sheet and then discount their value to arrive at the present value of the payouts.
“If the present value is higher than the current premium, it may be beneficial to buy the bond. Note the interest on SGBs is taxable, hence consider post-tax payouts,” says Raghaw.
Paying a high premium carries another risk. If the RBI resumes issuing fresh tranches, premiums may disappear, and SGBs could trade at a discount again, making the premium you paid seem like a mistake.
First Published: Sep 24 2024 | 8:06 PM IST
