BIG MONEY IN SGB REDEMPTION FOR INVESTORS

BIG MONEY IN SGB REDEMPTION FOR INVESTORS

With gold prices remaining at elevated levels, the government is starting to offer redemption options to the investors in sovereign gold bonds (SGB). For instance, the SGBs bought in early 2021 were recently offered for early redemption by the government. Take a recent example. The SGB 2020-21, Series VII, issued in October 2020 for ₹5,051 per gram, is being offered for early redemption at ₹15,554 per gram.

Now that is humongous returns in just 66 months. If you look at absolute returns, it is more than 200%. Even if you look at CAGR returns, it works out to an impressive 22.69%. That is something you would not have practically earned on any other asset class. For the investors, that is not all. They have already earned 2.5% per year as interest on the issue value of these bonds (albeit taxable), which will add to the yield on these SGBs. LTCG will be taxable.

BUT EARLY REDEMPTIONS ARE NOT EXACTLY PICKING UP

While the government has been regularly offering early redemption windows to the investors in sovereign gold bonds, the response has been quite muted. The table below will tell the bigger story.

Let us focus on the partial SGB redemptions through the early redemption window. The total size of partial redemptions is just about 0.530 tonnes. As a share of these series bonds issued, it is just 1.93%, which shows that the appetite for early redemption has been quite tepid. There are several reasons for muted response to early redemptions.

Firstly, investors do believe that the gold rally could continue. After all, gold has been the best performing asset class over the last 10 years and most Indian families still have much more trust in gold than in other asset classes. The bigger reason is the full LTCG exemption, which investors will lose out if they opt for early redemption of SGBs.

SHOULD INVESTORS OPT FOR EARLY REDEMPTION OF SGB?

That is a tough call, but let us look at the data on what would be the impact. Let us once again look at SGB 2020-21, Series VII; which was issued at ₹5,051 and where the government is offering early redemption at ₹15,554 per gram. How much will your CAGR returns over 5.50 years reduce, if you opt for early redemption?

As a result of the early redemption, you are required to pay LTCG tax at 12.5% on the capital gains. This reduces the CAGR returns on the SGBs over 5.50 years from 22.69% to 20.74%, which is a significant fall of 195 basis points. However, the LTCG exemption is only available after 8 years, which means you have to hold these bonds for another 2.50 years to be eligible for tax exemption. Investors have 2 choices.

Then can opt for early redemption and pay LTCG tax on the gains. Even post tax, they earn 20.74% CAGR over 5.5 years, which is phenomenal. This is an assured return, and the investor does not have to make any bets on higher gold prices later.

The second option is to wait for the full 8 years. You save LTCG tax, but take the risk of gold price movement over next 2.50 years. If gold goes down, you lose. If gold is steady, you still lose on time value. The advantage of waiting is only if gold prices actually go up.

Most investors look at tax exemption as the scoring point. However, the real issue is the uncertainty over gold prices. Gold has had long drawdowns in the past and that cannot be ruled out after the sharp rally in last 2 years. That makes the choice tougher for investors.

Investors would do well to remember 2 key rules before making the decision. Firstly, “if something is too good to be true, then it is possibly not true”. Secondly, “a bird in the hand is always worth more than two in the bush”.