In the last 8 years since the government started issuing sovereign gold bonds, it has been one of the big success stories in fund raising. The government raised a sum of ₹72,274 crore, by selling close to 146.96 tons worth of gold bonds. Until now, the government has redeemed just 16.84 tons worth of gold bonds, most of it as part of full redemption. Investors prefer to hold the SGBs for full tenure as it allows them tax-free capital gains. The big challenge is that there is another 130.12 tons of SGBs yet to be redeemed with market price twice the inflow price. 

There are 3 major costs that the center has to incur on SGBs. The first is 2.5% annual interest on the cost value of the bonds. Secondly, there is capital gains tax foregone since the bonds are exempt from capital gains tax, once the investor holds it for the full tenure of 8 years. But, the biggest cost to the government is the spike in gold prices. The government has given a sovereign guarantee on interest and on protecting capital in grams of gold. Between the first issue of SGB and today, the price of domestic gold is up 3-fold from ₹2,800/gram to ₹8,600/gram. 

That would entirely depend on the kind of gold prices that we see from here. If gold price falls, then the center stands to gain, but that looks unlikely. If gold stays at the current market price, the center will end up paying nearly 105% more than it realized. However, if gold prices are up by an average 20%, which is very likely, then the government may end up paying 136% more than what it realized from the issue of gold bonds. In the case of the gold price going up 40% on an average from here, the center would end up paying 167% more than it realized. In short, everything depends on the price of gold. Looking at the way gold has been rallying amidst global uncertainty, it does look like gold prices may have more legs in the days ahead. That is not good news. 

One can argue that timing was wrong. In a sense, the government expected that the 2017 revival would work against gold prices. However, the next few years were racked by uncertainty; including COVID pandemic, global inflation, Ukraine war, Middle East stand-off and now Trump tariffs. This mountain of uncertainty led to a spike in the demand for gold. While price spike was a big factor, there are 2 areas the government erred. Firstly, it should have stopped the SGB issues long back, at least around the pandemic. Of course, such a gold liability should not have been left unhedged in first place!