Ind-Ra: Gold Sovereign Bonds Arguably the Best Tool to Address Gold Import Issues

A gold sovereign bond is an attractive product and could address pure investment demand for the yellow metal, says India Ratings and Research (Ind-Ra) based on the recent draft guidelines by the government. The government is looking out for ways to address the fascination with gold in India by introducing such bonds.

Import of gold has affected the current account deficit. Gold sovereign bonds may triumph over other comparable products in the market such as gold exchange traded funds, physical bars and can lead to a reduction in India's current account deficit. Gold sovereign bonds are easy to implement relative to the gold monetisation scheme, the draft of which is also available.

A successful launch of this product may ensure that only the gold used for manufacturing jewellery forms part of the ever-growing import bill in India. Investors of gold bars or coins may find gold sovereign bonds a better investment than holding a physical stock, believes Ind-Ra. The most interesting and important advantage is that it may be a pure play of gold price without any handling and storage cost, which may be attributed to 'physical premium'.

Other advantages include that these bonds will relieve investors of the need to check the quality of gold which is a major hurdle when purchasing from local jewellers. Hence, such bonds are easier to use as collateral for both buyers and lenders. In terms of liquidating physical gold, there is a higher bid offer spread, while losses due to such spreads may be minimal in case of a paper or demat gold bonds. The only major risk all parties will bare is the market risk of gold price.

Retail investors often use the gold deposit schemes run by local jewelers and thus run a counterparty risk. In case of a gold bond, the counterparty is the government of India.

In India, investment demand for gold was 180.6 tonnes and formed 21.3% of total gold demand in 2014 according to the data from World Gold Council. When compared with the rest of the world, investment demand in the country for gold stands at 58.5% of the total gold demand. While jewellery demand in India is unlikely to come down any time soon, this new move by the government will move investors from the physical ownership of the metal to bonds. 

Figure 1

Investment Demand for Gold as a Proportion of Total Demand

Particulars World IndiaInvestment demand (tonne) 1259 180Total demand (tonne) 2152 842.7Investment as % of total demand 58.50 21.36Source: 2014 Data by World Gold Council for 2014

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