What are oil bonds, and to what extent do they tie the govt’s hands?

ContextThe government has attracted criticism post a surge in retail prices of petrol, diesel, and other petroleum product. However, the Finance Minister has blamed the oil bonds issued by the predecessor government for the current price countered. 

How much fuel price is taxed?

There are two components to the domestic retail price — the price of crude oil itself, and the taxes levied on this basic price. Together, they make up the retail price. 

The taxes vary from one product to another. For instance, as of now, taxes account for 50% of the total retail price for a litre of petrol, and 44% for a litre of diesel.

What is an Oil Bond?

An oil bond is an IOU (I owe you instrument), or a promissory note issued by the government to the Oil Marketing Companies (OMCs). It is given in lieu of cash that the government would have paid to OMCs.

An oil bond says the government will pay the oil marketing company the sum of, say, Rs 1,000 crore in 10 years. To compensate the OMC for not having this money straight away, the government will pay it, say, 8% (or Rs 80 crore) each year until the bond matures.

Why were they issued?

When fuel prices were too high for domestic consumers, governments in the past often asked oil marketing companies (OMCs) to avoid charging consumers the full price. But if oil companies don’t get paid, they would become unprofitable. 

To address this, the government said it would pay the difference. But again, if the government paid that amount in cash, it would have been pointless, because then the government would have had to tax the same people to collect the money to pay the OMCs.

This is where oil bonds come in. By issuing such oil bonds, the government of the day is able to protect/ subsidise the consumers without either ruining the profitability of the OMC or running a huge budget deficit itself.

What is the magnitude of Oil Bonds that needs to be repaid by the current government?

In 2014, there were bonds worth Rs 1.34 lakh crore that had to be paid between 2015 and 2026. 

Between 2015 and 2021, the government has fully paid off four sets of oil bonds — a total of Rs 13,500 crore. Further, between 2014 and 2022, the government had to spend a total of Rs 93,686 crore on interest as well as the principal of oil bonds. 

Source: Indian Express

Is this amount large enough to restrict the Finance Ministry from bringing down the taxes?

There are three ways to answer whether the amount is large enough to restrict a reduction in taxes.

The first is to observe that the total payout was just 7% of the total revenues earned through taxes on petroleum products in 2014-15. As the years progressed, this percentage has come down because taxes generated from this sector have soared.

The second is to look at the total revenue earned by the government (both Centre and states) between 2014 and 2022 from taxing petroleum products. This amount is more than Rs 43 lakh crore. That means the total payout by the current government to date on account of oil bonds is just 2.2% of the total revenues earned during this period.

The third way is to note that the total amount of revenue earned by the Centre from just one kind of tax— excise tax — in just — 2014-15 — was more than Rs 99, 000 crore. 

In other words, while the government has to pay for oil bonds, the payout is not big compared to revenues earned in this sector.

Source: This post is created based on the article “What are oil bonds, and to what extent do they tie the govt’s hands?” published in Indian Express on 16th April 2022

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