After a blistering 12.24% return on gold over the past year, the government has stepped in to curb imports of physical gold. In Budget 2019, finance minister Nirmala Sitharaman hiked the customs duty on the precious metal from 10% to 12.5%. The decision flew in the face of a recommendation NITI Aayog made in 2018 to reduce customs duty on gold to discourage smuggling and improve tax compliance. The duty hike makes buying physical gold yet more expensive for India’s retail investors and consumers.
At the same time, in a separate press release, the government announced a new tranche of sovereign gold bonds with a discount of ₹50 per gram for online payments. At an issue price of ₹3,443 per gram, this works out to a discount of 1.45%, which partially counteracts the customs duty hike of 2.5%. Sovereign gold bonds track the price of physical gold and also pay out an interest of 2.5%. Several banks allow investors to apply for sovereign gold bonds through internet banking and their websites.
However experts do not anticipate a large impact of the duty hike on domestic gold demand. “People buy assets when their past returns are high," said Nishith Baldevdas, founder, Shree Financial, a Chennai-based independent financial adviser. “The duty hike might perversely stimulate demand if it drives domestic prices higher," he said.
Financial planners have long regarded physical gold as an inefficient method of investment. Gold jewellery comes with making charges and service tax that substantially increases its cost. Storing physical gold safely also presents a problem for retail investors. “I don’t recommend physical gold as an investment. Gold jewellery should be viewed as an item of consumption rather than investment," said Kalpesh Ashar, proprietor, Full Circle Financial Advisors, a financial planning firm.
In fact, when it comes to paper or electronic gold, sovereign gold bonds are the best option. “The only drawback they suffer from is the lack of liquidity," said Ashar. A sovereign gold bond has a tenor of eight years, but investors are allowed to prematurely redeem it after a five-year period. The capital gains on these bonds on redemption are exempt from tax although their interest component is taxable at a person’s income tax slab rate. If the investor sells it to another person before maturity, the capital gains accrued become eligible for indexation. An individual can apply for a minimum of 1 gram and a maximum of 4 kg per annum.
Apart from physical gold and sovereign gold bonds, retail investors can also buy the yellow metal through open-ended gold mutual funds, gold exchange-traded funds (ETFs) and digital gold which is offered by online apps such as Paytm. Gold funds and ETFs offer investors greater flexibility than sovereign gold bonds since an investor can exit them on any trading day. However, they do not get the interest rate and tax benefits that are available on sovereign gold bonds.
The price of gold peaked in 2011 after a multi-decade bull market. The precious metal delivered poor returns in the seven years that followed. Assets in gold ETFs fell from more than ₹10,000 crore in June 2012 to ₹4,930 crore as of June 2019, according to data from the Association of Mutual Funds in India (Amfi).
However, the precious metal has seen a revival in the recent past. It’s one-month returns are 6.59% and three-month returns are 9.15%, as represented by Reliance ETF Gold BeES, which tracks the price of gold. The price of gold is also closely related to the monetary policy outlook in the world’s major economies. A looser monetary policy stance in the US has revived the prospects of gold.
Gold should not account for a significant part of an investor’s portfolio. It is not a productive asset and earns returns simply on the basis of its limited supply. However for those who wish to invest in it, sovereign gold bonds have emerged has a highly efficient vehicle and their relative attractiveness has been reinforced by the latest duty hikes on physical gold. They are also the only type of gold-linked investment that earns regular interest.
Although they do not provide liquidity, investors have other options for liquid assets such as fixed deposits and liquid funds.