RBI's Early Redemption On SGBs: All You Need To Know About The Returns

Key Takeaways

1. The RBI announced premature redemption for Sovereign Gold Bonds (SGBs) issued on 22nd January 2019, with a reported 205% return over 6 years.

2. SGBs are bonds issued by the RBI, linked to gold prices, offering capital appreciation and a 2.5% annual interest.

3. The January 2019 SGB tranche provided a Compound Annual Growth Rate (CAGR) of up to 19.03% and an Internal Rate of Return (IRR) of up to 20.78%.

4. The government stopped issuing new SGBs due to the high cost of borrowing, as gold prices rose significantly, increasing the government's liability.

5. Investors can still buy SGBs in the secondary market, but liquidity is low as most holders are reluctant to sell.

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Last week, the RBI via its press release, announced the premature redemption for the Sovereign Gold Bonds (SGB) issued on 22nd January 2019. Now, the media is buzzing with a “205%” return on the investment.

But this return is over 6 years.

So today in this blog, we’ll talk about early redemption, uncover the annual returns this SGB tranche has given investors, talk about why the government has stopped issuing SGBs now, and also discuss how investors can still invest in them.

Let’s begin..

First, how do SGBs work?

Sovereign Gold Bonds are nothing but bonds issued by the RBI, whose price moves in line with gold prices. Each unit of the bond corresponds to 1 gram of gold. So if you buy 10 units, this means you’re investing an amount equal to 10 grams of gold.

Now, the price of the bond moves in line with gold prices. So at the time of redemption, each unit can be redeemed at the price of 1 gram of gold, at that time. This means that by holding the bond, you get capital appreciation in line with gold prices. Along with that, the RBI also pays a 2.5% interest every year (paid semi-annually) on the nominal value of the bond.

The price (at the time of issuance and redemption) is calculated based on the average closing price of 1 gram of 999 purity gold published by the India Bullion and Jewellers Association (IBJA) for the last three working days before the price is declared.

Example:

If gold prices per gram for the last 3 working days before issue are:

• ₹6,150

• ₹6,180

• ₹6,170

Then, the nominal value = (6150 + 6180 + 6170) ÷ 3 = ₹6,166.67

If you apply for the SGB online, there is also a discount of Rs. 50 per gram.

SGBs have a tenure of 8 years, but can be redeemed after 5 years of issuance. This is where the RBI has announced premature redemption for bonds issued on January 22, 2019. After 5 years of issuance, premature redemption can be done every 6 months.

Here’s how the premature redemption process works:

• Investors apply for premature redemption before the coupon payment date

• RBI announces the redemption price (average of last 3 days of closing prices published by IBJA) before the coupon payment date

• Investors get the sum in proportion to the number of units they have redeemed

Now, let’s dive deep into the 205% return on the January 2019 tranche

Before diving into the analysis on returns, let’s look at the values:

• Nominal value per gram on 22 Jan 2019: Rs. 3,214

• Redemption value per gram on 22 July 2025: Rs. 9,820

Let’s dive deeper.

1. Absolute returns

If you were an investor in the SGB 2018-19 Series-V bond, you made 205% returns.

If you purchased the bond online, there was a Rs. 50 discount per gram. That makes it a 210% return for online investors.

Now, if you add the coupon payments to it, you get an additional Rs. 522.28 over 6.5 years. This makes your absolute return 220%.

But as you know, absolute returns tell nothing without the duration. So let’s dig deeper.

2. CAGR

When purchased offline, for the said duration, this tranche gave a CAGR of 18.75%.

With the online discount, your CAGR becomes 19.03%.

Now, let’s also incorporate the coupon payments and calculate the IRR for the SGB

3. IRR

Here’s the schedule for the bond

With an offline payment, you get an IRR of 20.48%.

If you opt for the online mode, the IRR further increases (though marginally) to 20.78%.

If you ask us, this kind of return on any investment is something most investors can only dream of.

Okay, great returns! But why are they not available now?

Well, SGBs were great for investors. Not so great for the government.

The primary reason for introducing SGBs was to reduce the strain on India’s Current Account Deficit (the situation where a country's total imports of goods, services, and transfers exceeds its total exports and transfers out).

You see, India imports a LOT of gold (approx 800-1000 tonnes a year), and this, in the past, strained our forex reserves and widened the Current Account Deficit (CAD). By offering a government-backed bond tied to the price of gold (with a fixed 2.5% annual interest), the idea was to give investors an attractive “paper gold” alternative. The hope was that households would buy bonds instead of gold bars or jewellery, thereby keeping more capital in India.

What the government probably underestimated, was the exponential rise in gold prices that would happen.

The SGBs were not really backed by physical gold (honestly, that would defeat the whole purpose of issuing them in the first place). And while the government did create a Gold Reserve Fund, it only minimised the risk; didn’t eliminate it.

And then it happened – You read the analysis. Gold gave annual returns up to 20% in some cases – something even the best equity funds were not able to do.

This meant the government’s liability increased.

Thanks to this increased cost of borrowing, the government stopped issuing fresh SGBs. In fact, our finance minister also hinted at discontinuing the SGB scheme, in a way.

Can you still invest in them?

In theory, yes. You can always buy these SGBs in the secondary market, i.e. you can buy it, like you buy a stock, on the exchange, from someone who wants to sell it, on a platform like Zerodha, Groww, Axis Direct or any other broker.

In practice though, the liquidity is very low, since most SGB holders don’t want to sell SGBs now. So you may or may not be able to buy them, depending on whether people want to sell them or not.

All in all, while investors loved the SGB scheme, it didn’t work out very well for the government. At least not as well as they had expected. Whether or not there will be any more tranches in future, only time will tell.

Till then, let’s wait and watch.

Until next time…

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Please note that this is an opinion blog and not an official research or investment advice. This blog neither encourages nor discourages you from investing in any particular asset class or platform.

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