Why SGBs are becoming a headache for the Indian Government?
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Sovereign Gold Bonds (SGBs) were introduced in India in 2015 with high hopes and grand ambitions. Developed jointly by the Reserve Bank of India (RBI) and the government, SGBs were envisioned as a tool to curb the country's gold obsession, reduce gold imports, and provide a safer, government-backed investment alternative. However, what began as a strategic financial move to solve economic issues has evolved into a significant challenge for the Indian government. The idea behind Sovereign Gold Bonds was straightforward. Instead of purchasing physical gold, investors could buy bonds tied to gold prices. These bonds offered an annual interest rate of 2.5%, and the returns were tax-exempt at maturity. The government hoped that by making this alternative attractive, it could reduce the high demand for physical gold, thereby decreasing gold imports and improving the current account deficit. Initially, the scheme was a success. Investors were drawn to SGBs because they provided exposure to gold without the hassle of storage or security concerns. Furthermore, the tax-free returns and the steady annual interest made SGBs a compelling choice compared to other investment options. However, the financial landscape began to shift dramatically with the surge in gold prices. Between 2015 and 2024, gold prices in India skyrocketed by 180%. This unexpected rise created a significant financial burden for the government. For instance, the first tranche of SGBs issued in 2015 was priced based on gold valued at INR 2,684 per gram. By the time these bonds matured, the price had soared to INR 6,132 per gram—a staggering increase of 128%. This dramatic escalation meant that the government had to pay out significantly more than anticipated. For the first batch of SGBs, the total payout was approximately INR 609 crores, far exceeding the INR 245 crores initially raised. This disparity resulted in a financial shortfall of about INR 193 crores, highlighting a major issue with the scheme’s sustainability.
The government’s predicament is clear: the soaring gold prices have turned what was intended to be a cost-effective borrowing tool into an expensive financial obligation. As more SGB tranches mature over the coming years, the government faces a growing financial burden. With gold prices likely to remain volatile due to global uncertainties and market dynamics, the potential for further financial strain is significant. Moreover, the expectation that gold prices would remain stable or decline, which was a key factor in the initial decision to launch SGBs, has proven to be overly optimistic. The unanticipated rise in gold prices has not only increased the government’s payouts but also raised concerns about the overall viability of the SGB scheme. Given the current situation, the government has a few potential courses of action. It could halt the issuance of new SGBs until gold prices stabilize or explore modifications to the bond structure. Possible adjustments could include altering the tax treatment of returns or adjusting the interest rates. However, such changes could make SGBs less attractive to investors, undermining the very appeal that led to their initial success. The RBI and the government have already reduced the projected issuance of SGBs for FY25 from INR 29,600 crores to INR 18,500 crores. This reduction reflects the growing concerns about the financial implications of continuing the scheme in its current form. As of now, no new SGBs have been issued recently, and the future of the scheme remains uncertain. The government faces a delicate balancing act: managing the financial impact of rising gold prices while maintaining investor interest in SGBs. The upcoming decisions on whether to continue, modify, or phase out the SGB program will be closely watched.
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