India’s Sovereign Gold Bonds: An Example For The World To Follow?

Earlier this week, India announced it would issue another series of gold-linked bonds. These still represent just a tiny portion of the government’s funding needs, but the move is symbolically important – not only may such bonds eventually play a more meaningful role fulfilling India’s government financing needs, but they may do so for other countries, too.

All else unchanged, the issuance of gold-backed securities of any kind, be they bonds, certificates, ETFs, or any other structure, should be positive overall for gold investment demand and, therefore, for the price of gold.

Advantages of Gold Bonds

India’s announcement of the new series of Sovereign Gold Bonds (SGBs) comes alongside a surging government budget deficit, driven higher in no small part by Covid-19 and the associated national and international lockdown measures, which have resulted in a collapse of economic activity and consequently tax revenues. As with previous issues beginning in 2015, the bonds have maturities of up to eight years, will pay an annual coupon of 2.5%, and the principal due at maturity will be linked to the market price of gold. While the coupons will be taxable income, any capital appreciation is not subject to tax. So the bonds offer both a convenient and tax-efficient way for private Indian savers to protect their wealth.

Yet SGB take up has been slow because traditionally Indians save gold in physical form. Even today, following five years of the programme, SGBs account for less than 1% of total central government debt. However, the nominal amount has grown at a rate of about 10% over the past year and, with the decision to continue expanding the programme, growth is likely to continue.

Gold Bonds Are Not a New Idea

In any case, what India’s SGB programme lacks in quantity it makes up for in quality: that is, an example to the world that an old idea – gold-linked government debt – is a potentially useful form of low-cost financing. Indeed, long after the world abandoned the classical gold standard in the early 20^th century, never to properly return, gold-linked government bonds have been proposed a number of times.

In fact, former Fed chairman Alan Greenspan did just that in 1981 while working as an economic consultant and occasional advisor to the US government. The US was then suffering from severe ‘stagflation’, and confidence in the US economy and currency was faltering. The price of gold was soaring, to over $800 at one point. Where most policy makers saw risk, Greenspan saw opportunity. The higher price of gold implied that US gold reserves were worth far, far more than their book value of only $42.22. Indeed, he believed that, with gold prices so high, the US should seriously consider not only the opportunity to issue gold-linked bonds but also to re-link the dollar itself to gold. As he wrote in the Wall Street Journal in September that year:

“The major roadblock to restoring the gold standard is the problem of re-entry. With the vast quantity of dollars worldwide laying claims to the US Treasury’s 264mn ounces of gold, an overnight transition to gold convertibility would create a major discontinuity for the US financial system. But there is no need for the whole block of current dollar obligations to become an immediate claim… Convertibility can be instituted gradually by, in effect, creating a dual currency with a limited issue of dollars convertible into gold. Initially they could be deferred claims to gold, for example, five-year Treasury Notes with interest and principal payable in grams or ounces of gold.”[1]

Greenspan also noted in the article that there would be immediate benefits to issuing gold-linked US Treasury securities – namely that the market would accept far lower interest rates than the double-digit market yields observed at the time. Indeed, he estimated that the rates payable would be “2% or less” based on imputed interest rate calculations from the gold swaps market. This is, not coincidentally perhaps, the same order of magnitude of interest payable on Indian SGBs today, which is also far below the rate on non-linked Indian government debt.

Following his terms as Fed Chairman and the opportunity to watch the global financial crisis unfold in 2008-9, Greenspan has continued to offer his thoughts on this controversial topic. In an interview with the World Gold Council in 2017, he comes close to recommending a return to a full gold standard as the best way to deleverage and rebalance the global economy.[2]

Could Gold Bonds Make a Global Comeback?

With the Covid-19 shock now arriving with potentially great stagflationary force, it is again worth considering Greenspan’s views on this matter. As it happens, Trump’s recent nominee to the Federal Reserve Board, Judy Shelton, has proposed the issuance of gold-linked Treasury securities on multiple occasions. If confirmed by the Senate, it is likely that the idea will receive more attention.

It is not only in India and the US where gold-linked bonds have attracted serious consideration. Indeed, in the midst of one of the greatest economic crises of the 20^th century, that of Russia in the early 1920s, even the revolutionary Soviet government recognised the potential usefulness of borrowing against the country’s gold reserves (and future gold production) by issuing gold-linked debt. Lenin famously championed this alongside the various economic liberalisation measures comprising the New Economic Policy (NEP) announced in 1921. By 1923, in a series of steps, Soviet Russia returned to a gold standard and introduced a new circulating gold coin, the Chervonet.

If not for Lenin’s untimely death and Stalin’s decision to abandon the NEP the following year, Soviet Russia might have remained on the gold-standard indefinitely. It is impossible to know. But what we do know is that, throughout history, countries of all kinds—Capitalist, Socialist, Mixed – have found it attractive to issue gold-linked debt in order to reduce funding costs when running large deficits and facing rising costs on unsecured borrowing.

History doesn’t repeat, but it occasionally does rhyme, and perhaps India is but the first mover to capitalise on its gold reserves this time round.

[1] Alan Greenspan, “Could the U.S. Return to a Gold Standard?”, the Wall Street Journal, 1 September 1981.

[2] The World Gold Council, Interview with Alan Greenspan, Gold Investor, February 2017.

John Butler has 25 years experience in international finance. He has served as a Managing Director for bulge-bracket investment banks on both sides of the Atlantic in research, strategy, asset allocation and product development roles, including at Deutsche Bank and Lehman Brothers.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)