Oil bonds and other associated issues – Explained, pointwise

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Introduction

The Centre has argued that it cannot reduce taxes on petrol and diesel, as it has to bear the burden of payments in lieu of oil bonds issued by the previous government to subsidize fuel prices.

Fuel prices as of now remain incredibly high, with many metro cities having to pay more than Rs 100/litre of petrol.

Let’s analyze the entire issue step by step:

Deregulation of oil price

Situation prior to deregulation: Prior to deregulation, the government would intervene in fixing the price at which retailers were to sell diesel or petrol. Govt did this to keep the fuel price cheaper. But, it led to under-recoveries for oil marketing companies, which the government had to compensate for via subsidies.

Hence, the prices were deregulated to make them market-linked, unburden the government from subsidizing prices, and allow consumers to benefit from lower rates when global crude oil prices dipped.

Fuel price decontrol (deregulation) happened gradually:

  • Aviation turbine fuel in 2002
  • Petrol in 2010
  • Diesel in 2014

Present situation: Since deregulation, the public sector Oil Marketing Companies make decisions on the pricing of petrol and diesel based on international product prices, exchange rate, tax structure, inland freight, and other cost elements.

Now, let’s understand, what are oil bonds and how they came into the picture.

What are oil bonds?

These are bonds issued to oil marketing companies, instead of cash subsidies. They have a 15-20 year life, during which the government pays the companies interest on the amount. Once the bond is due, the total amount will have to be paid.

  • Moreover, oil bonds do not qualify as statutory liquidity ratio (SLR) securities, making them less liquid when compared to other government securities.
  • Oil bonds can be traded for liquid cash by sale in the secondary market to insurance companies, banks, and other financial institutions. The government, being the issuer, would bear the interest payments and redemption at maturity.

As discussed above, before the deregulation of oil prices, the oil companies faced tremendous losses. Govt used to fix the price, and companies had to sell at a lower selling price as compared to the international market price. To compensate for their losses, govt-issued subsidies to them by issuing oil bonds, totaling Rs. 1.34 lakh crore to the state-fuel retailers.

Note: A bond is nothing but a piece of paper via which someone promises to return your money, along with interest, after a specified period of time. In this case, govt owed money to oil companies and decided to pay via issuing bonds so that it doesn’t have to pay them cash subsidy immediately.

Oil bonds dues
Source: The Hindu Business line

Note: Of the Rs 1.34 lakh crore worth of oil bonds, only Rs 3,500 crore principal has been paid and the remaining Rs 1.3 lakh crore is due for repayment between this fiscal(2021-22) and 2025-26.

Issuing such bonds, to delay paying expenses immediately, is not a new practice. It has been done in other sectors as well.

Previous instances

Bonds which subsidized payments have been issued earlier too:

  • Fertilizer bonds: Previous govt’s era also saw the issuance of fertilizer bonds from 2007 to compensate fertilizer companies for their losses due to the difference in the cost price and selling price.
  • Recapitalization bonds: Over the years, the present government has issued bank recapitalization bonds, worth Rs 3.1 lakh crore, to specific public sector banks (PSBs) to meet the large capital requirements of these PSBs without allocating money from the budget. These bonds will come up for redemption between 2028 and 2035.
Rationale behind issuing bonds by the government

In all the above cases, instead of providing direct cash, govt preferred issuing bonds for the following reasons:

  1. Compensation for the subsidies: To shield the domestic consumer from the harmful effects of higher prices (inflation) of a commodity, the government tries to maintain its price to a cheaper level. But, in this case, companies would need to be compensated for their losses. This is done via issuing of bonds. Now, this could also be done via giving away direct cash subsidy, which is usually not preferred because of the following reason.
  2. Controlling the fiscal deficit: Compensation to companies through issuance of such bonds is typically used when the government is trying to delay the fiscal burden of such a payout to future years.
    Governments resort to such instruments when they are in danger of breaching the fiscal deficit target due to unforeseen circumstances.
  3. Resource constraints: Being a developing country and as a welfare state, the Indian government is constantly under fiscal pressure with so many competing demands such as food security, vaccination, social welfare, etc. Hence, the usage of government funds has to be rationalized as per priority and if something can be paid gradually over time then it is the preferred way.

But, this approach does have its negative implications:

Issues/concerns
  1. Increase in overall debt burden: These types of bonds do not have an impact on that year’s fiscal deficit, but they do increase the government’s overall debt.
  2. On future fiscal deficit calculations: Interest payments and repayment of these bonds become a part of the fiscal deficit calculations in future years.
  3. No long-term value: These bonds do not contribute anything towards the generation of any long-term viable assets for the country. They are just used as a means to delay the payment burden over time. Hence, they don’t generate any revenues for the economy, acting as a liability.
Suggestions/Measures

Being a developing country, our needs will always outpace our fiscal capacity. Hence, this issue can only be solved by taking steps that have a long term impact:

  • Shift to a greener economy: We can try and reduce wasteful consumption of conventional fuels and focus on alternative and renewable sources of energy. Also, instead of an overreliance on chemical fertilizers, farmers should be encouraged to shift towards biological farming solutions. Moreover, in light of the recent IPCC report, all these changes are no longer an option, but a necessity.
  • Rationalizing the subsidy burden: Subsidies are also one of the reasons why such bonds are being issued. Though necessary, they must be rationalized to ensure that they are targeting the right segments of the population who are in genuine need. This will also lead to a reduced subsidy burden on the exchequer.
Way forward

Issuing bonds to cover up the subsidy bill is never a long-term solution because it’s akin to passing on the burden to our future generations. But, seeing the resource crunch that a developing country like India is always in, we can aim to strike a balance between competing demands of our economy.

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