SGBs & gold customs duty – was the Govt. unfair to investors?

Some investors, especially on social media, haven’t yet recovered from the tax changes announced in the Budget last week. Apart from fretting over the hike in capital gains tax on equities and property, they’ve also been worrying over conspiracy theories on the budget proposal to sharply cut import duties on gold.

But tweaks on gold import duties are quite commonplace and not really targeted at investors in Sovereign Gold Bonds (SGBs) or other gold-backed instruments. Here’s an FAQ clarifying this move and what it means for investors in gold instruments, particularly SGBs.

Q Why did gold prices fall so sharply after the Budget?  

India imports most of its requirement of gold from global markets. Therefore, local prices of gold track international prices after adjusting for customs duty and the exchange rate. The Budget on July 23 announced a sharp cut in the customs duty on gold bars from 15% to 6% and gold dore from 14.35% to 5.35%. These are the main forms in which gold is imported into India.

After factoring in the impact of GST, this made the cost of imported 24-carat gold into India cheaper by Rs 5,692 per 10 grams on the pre-budget price of Rs 74,080 per 10 grams. Therefore, the price of gold in domestic markets fell by over Rs 5,000 after the Budget. It now rules at about Rs 68,950 after recouping some lost ground. This has led to a similar 5-6% decline in the traded price of Gold Exchange Traded Funds (ETFs) and Sovereign Gold Bonds (SGBs), which track 24-carat gold prices.

Q   Why did the government do this, knowing it will result in a loss to SGB holders?

The Central government uses customs duty changes to control gold imports, which have a bearing on the current account deficit (CAD) and Rupee movements. Gold import duties have, in fact, been steadily increased in the last decade.

This cut, the first in eleven years, was made to give gems and jewellery exporters from India a shot in the arm. Gems and jewellery exports have been falling on lacklustre global demand post-Covid. These exporters work on very thin margins and a cut on gold import costs can add materially to their global competitive edge. The Budget has also cut import duties on many electronic inputs with a similar objective of encouraging electronics exports.

The duty cut also helps curb illegal imports into India by way of smuggling, which has been on the rise since the import duty hike in 2022.

Q Still, it is unfair of the government to sell SGBs to retail investors at a high price and then trigger a price fall with a duty cut, isn’t it?  

SGB holders need to note that if they have made losses from the recent duty cut, they have also made gains when the government increased the customs duty on gold in the last nine years.

When SGBs were first introduced in November 2015, the import duty on gold was 10%. This was hiked to 12.8% in July 2019 and 15% in July 2022. These increases lifted domestic gold prices and thus helped investors in SGBs and ETFs who were able to sell after these hikes, pocket gains. Two tranches of SGBs have also been redeemed at those higher prices when the 15% import duty was in force.  

Here’s the history of gold duty changes since 2012.

You will notice from the above history, that increases in gold customs duty have been more frequent than cuts. This is because whenever the government perceives a spike in gold demand or oil prices, an expanding CAD, foreign exchange outflows or any other threat to the Rupee, it usually reacts with a customs duty hike on gold to discourage imports. Investors in SGBs and other gold instruments in India therefore need to be aware that duty changes are very likely, and that will impact their final returns from these products.

SGB holders hurt by this duty cut can also hang on in the hope that the duty could be hiked, sometime before their SGBs come up for maturity.

Q But haven’t holders of SGBs have permanently lost Rs 5,000 per gram because of the duty cut?

Customs duty changes are only a minor factor deciding gold price returns in India. The main - and much bigger - drivers are changes in international gold prices and Rupee-US Dollar movements. International gold prices can spike on a host of factors – financial crises, geopolitical tensions, war, a spike in crude oil prices, natural calamities, terrorist attacks, inflation worries and even rate cuts in the US. In addition, any depreciation of the Rupee against the US dollar due to foreign exchange outflows or other events, also adds to gold price returns in India.

Therefore, if you hang on to your SGB till maturity, the loss from the customs duty cut can be made up by other factors that spike up global gold prices or weaken the Rupee. This previous research report on gold discusses some of the factors firing up gold price returns.

Q Customs duty cuts help the government save on borrowing costs, because it gets to redeem SGBs at a lower maturity price. With some SGBs coming up for redemption, doesn’t it still seem like it could be a motive for duty cuts?

Yes, if domestic gold prices are ruling at low levels when SGBs come up for maturity, the government does get to save on its outgo. But it would be silly for the government to tinker with gold import duties just for this reason alone - gold duty cuts can have a very significant macro-economic impact.

One impact of a sharp duty cut is that lower gold prices can spur demand for gold and cause India’s gold import bill to spike. In fact, the recent gold price fall is already attracting more buyers to the jewellery stores. SGBs were originally introduced in 2015 mainly to nudge Indian consumers from physical to paper gold, so that the import bill can be contained and the Rupee shielded from a fall.

Weighed against this impact, the savings the government will make on its outgo on SGB redemptions will be negligible. This is because all the SGBs issued from FY16 till date account for less than Rs 75,000 crore in Central government borrowings - which is less than 2% of its outstanding debt stock. Therefore, duty cuts on gold would be a drop in an ocean if the government is trying to save on its outgo on borrowings.  

Q Does this duty cut make SGBs less attractive than other kinds of gold investments such as gold ETFs?

No, it doesn’t. Gold duty increases or cuts equally impact SGBs, gold ETFs, gold funds and other instruments pegged to the domestic price of gold, because all these instruments are benchmarked to the Indian price of gold in Rupees. SGBs will remain superior to these instruments due to the additional interest of 2.5% pa paid out by the government, the sovereign backing and the exemption on capital gains for primary individual buyers.