SGBs: Tax bandaid for a self-inflicted fiscal wound

The Union budget presented by Nirmala Sitharaman on 1 February indirectly acknowledges a simple fact: that the government goofed in giving citizens a free ride on sovereign gold bonds (SBGs). SGBs currently have a tenure of eight years, but they are completely free from long capital gains tax (LTCG) if held to maturity. The interest, of 2.5 percent, is taxable.

But Sitharaman now wants to ensure that these bonds pay LTCG unless they were bought at the time of original issue and held till maturity. It means that those who bought SGBs from the market have to pay capital gains tax. LTCG is charged at the rate of 12.5 percent.

Sitharaman said in her budget speech:

“It is proposed to provide that the exemption from capital gains tax in respect of sovereign gold bonds shall be available only where such bonds are subscribed to by an individual at the time of original issue and are held continuously until redemption on maturity. It is also proposed to provide that this exemption applies uniformly to all issuances of sovereign gold bonds by the Reserve Bank of India.”

Now, why would the government want to change the SGB tax goalposts just when the rest of the budget seeks to provide tax certainties in other areas, including for IT- and IT-enabled services, where “safe harbour” provisions have been rationalised at 15.5 percent? 

The answer lies in three words: runaway gold prices. Prices have been on a tear from the time geopolitical risks escalated with the start of the Russia-Ukraine and West Asian wars and Donald Trump’s decision to weaponise tariffs to get his trade partners to buy more from America. 

From the time when the government first wised up to the fact that SGBs were not a bright idea, and now, gold prices have more than doubled. When the last tranche of SGBs was issued in February 2024, gold was priced at Rs 6,263 per gm (ie, the price taken for the SGB issue). At around 1030 am on 5 February, the price of gold was hovering around Rs 15,970 per gm -  a rise of more than 150 percent in less than two years. The decision to discontinue was a good one, but the liabilities remain daunting.

The government’s total liabilities at current market prices are a massive Rs 197,000 crore-and-odd on SGBs equivalent to 12.37 crore gm. While this liability will have to be borne in stages, and can even come down if gold prices start moderating, nobody is betting that gold prices will fall to the levels we saw in February 2024, when SGB issuances were suspended. The world is not going from extreme uncertainty to a benign state no matter what happens. Not when we do not know where the dollar is headed. Gold is the ultimately safe haven, because even governments cannot easily touch them.

Our government has been desperate to bring gold prices down since 2024. In July 2024, the finance minister slashed gold import duties from 15 percent to six percent. But it didn’t help bring down domestic prices when global prices were zooming. More recently, the Central Board of Indirect Taxes and Customs cut the base import price of gold and silver.

The move in the latest budget to end capital gains exemption for SGBs bought from the market is an attempt to put a finger in the dyke, a bid to recoup some of the future losses.

I have always believed that it is a bad idea for governments to go against what is so ingrained in the Indian psyche (read here, here). Attempts to wean citizens away from the attractions of this “barbarous metal” have always been less than successful. And not when central banks are not practising what they preach. In the wake of global uncertainties, and especially after America and Europe started confiscating Russian central bank reserves after the start of the Ukraine war, governments have been moving away from the dollar.

Russia, China and India have been stockpiling gold for years now (see here).

It is not clear how much of the outstanding issues of SGBs were obtained through market purchases, but even if it is substantial, the LTCG will not be enough to compensate for the huge increase in liabilities on the repayment front and the opportunity losses on bonds held to maturity. It has to repay 12.37 crore gm of gold at equivalent market prices at the time of redemptions of outstanding SGBs. As noted above, that is just under Rs 2 lakh crore in terms of future liabilities today.

The LTCG move is a tax bandaid for a self-inflicted fiscal wound that will have to be unwound steadily till 2032.