Sovereign Gold Bonds: Will Gold Reserve Fund end up as an elephant in the room?

The government has on 9 September 2015 ironed out the minutiae of the sovereign gold bond scheme announced in the budget 2015. The bonds would be of five to seven years durations and come in denominations of 5, 10 grams etc. thus making them medium term investments at par with deposits of similar tenure under the simultaneously announced Gold Deposit Scheme (GDS).[caption id=“attachment_2355816” align=“alignleft” width=“380”] Representational image. Reuters[/caption] The elephant in the room however is Gold Reserve Fund (GRF) the understated linchpin of the scheme. GRF will be created by transferring the notional savings in the cost of borrowings thanks to the scheme accruing to the government. To wit, if the government mobilizes Rs 500 crore through sovereign gold bonds in the fiscal year 2015-16 at a coupon rate of 7 percent interest whereas the market rate for similar maturities for sovereign borrowings through traditional means is say 7.5 percent, the saving of half percent yields in absolute terms a saving of Rs 2.5 crore which will be transferred to GRF. The GRF balance would be ultimately used to bail the government out of the bind should gold prices be higher vis-à-vis the price prevailing at the time of issuance. Can a scheme be allowed to rest on such a nebulous and possibly niggardly reserve? The scheme itself envisages the possibility of GRF not being enough to make the bonds self-sustaining. What happens if the savings are as small as Rs 2.5 crore as envisaged in the above example whereas the tabs to be picked up by the government are manifold this amount? Notional savings are at any rate difficult to compute and capable of diverse interpretations. How to compute the cost of borrowings for the government? Would it be revealed in retrospect after the year is over? If that is the case would last year’s rates be the bases for the next year? Would domestic borrowings be taken into account or international borrowings also? This is not mere hairsplitting because foreign currency sovereign borrowings may be cheap but adverse exchange rate fluctuations can upset the applecart. That market can work against the investor should be apparent to anyone. The scheme says if the market rate of gold go down at the time of redemption vis-à-vis what it was at the point of issuance, the investors would be allowed to roll over for two or three years so that they can redeem their bonds when times are propitious for them. Will this be sustainable for the government? Why should the downside risk be borne only by the government directly or indirectly? How can investors be made to feel win-win – heads I win tails you lose. Would it be roll over in perpetuity? The raison d’etre of sovereign gold bonds is to make investment in physical gold unattractive but rural folks who invest in gold as much as their urban counterparts may not evince much interest in the scheme. This is because while GDS will be operated by banks closer to their hearts thanks to Jan Dhan Yojana, bonds leave them befuddled thanks to their esoteric character and lack of financial literacy. Revenue neutral rate has been the nemesis of the GST bill that has been hanging fire for long. Gold Reserve Fund could similarly be the nemesis of sovereign gold bond scheme. Both are vague concepts. Saving in cost of borrowings is admittedly notional. This could be exacerbated by another question – what all go into the government borrowing basket?