The economics of Oils Bonds

While replying to questions raised in the Parliament regarding high petroleum prices in India, Finance Minister Nirmala Sitaramaiha stated that rates of petroleum products cannot be reduced due to the interest payments that the Indian Government has to do on Oil Bonds issued by the Manmohan Singh regime.

• Oil bonds were issued by the Congress-led UPA (United Progressive Alliance) government between 2005 and 2010 to insulate consumers from price shocks.
• They are issued by the government to compensate oil marketing companies for not passing on the higher costs to consumers.
• These were issued at the time when oil prices were not market linked but dictated by the government.
• The bonds could be redeemed at a later date by oil marketing companies, usually after 10-15 years.

What are Oil Bonds?

• Oil bonds are issued by the government to compensate oil marketing companies (OMCs) to offset losses that they suffer to shield consumers from rising crude oil prices. 
• Under this mechanism the government reimburses oil companies, for subsidies on petroleum products, by issuing long-term bonds that they could redeem at a later date, typically ranging 15-20 years.
• The government issued these bonds mainly during 2005 to 2010.

Why were the Oil Bonds issued?

• Oil bonds were used by the previous government to insulate the consumers from rising prices of petroleum products and to avoid the ballooning of government’s fiscal deficit.
• During the abovementioned period, i.e. 2005 to 2010, the global oil prices had picked and reached record high.
• As the government of the time wanted to avoid burdening the consumers to pay the whole amount, they directed the Oil Marketing Companies (OMCs) to sell the petroleum products at cheaper rates (controlled price).
• However, compensating the OMCs for the difference in value between the actual price and the retail price of petroleum products was necessary from the point of view of their financial viability.
• Ideally in the above situation, it must have been the government of the time who should have paid for the difference in price but that would have increased the fiscal deficit of government and thus constraint it from undertaking welfare measures.
• It has to be also remembered that the global recession came about in 2008 causing economic slowdown all around the world including India.
• The priority of Indian Government therefore at this time was to utilise its limited fiscal resources for the purpose boosting economic activities in the country.
• An alternative path therefore was taken up by the Manmohan Singh government under which Oil Bonds were issued to the OMCs.
• It is prudent to remember that, in essence, these bonds are like promissory notes of deferred payment of subsidies that the government owes to oil marketing companies.
• Since the government did not subsidise these companies upfront, these payouts did not show up in budget documents, until the repayment of the principal or interest components took place.
• As a result petroleum products were made available to the people of India without increase seen in the fiscal deficit at that point of time and OMCs being saved from dreadful under-recoveries.

What are under-recoveries?

Under recoveries are revenues foregone by state-run refiners for selling fuel below cost. This is what kept diesel and petrol prices artificially in check.

What are total outstanding payments on oil bonds?

• An oil bond says the government will pay the oil marketing company the sum of, say, Rs 1,000 crore in 10 years.
• And to compensate the OMC for not having this money straightaway, the government will pay it, say, 8% (or Rs 80 crore) each year until the bond matures.
• The government has so far paid Rs 70,195.72 crore as interest on oil bonds in the last seven years.
• Of the Rs 1.34 lakh crore worth of oil bonds, Rs 3,500 crore principal has been paid and the remaining Rs 1.3 lakh crore is due for repayment until 2025-26.

Are the Oil bonds really the reasons for high petroleum prices?

• Objectively it cannot be said that the oil bonds are in actuality the only reasons for high fuel rates in India.
• The finances of Oil bond show that the repayment of money to OMCs is a minuscule amount of the total revenue received by the government in form of taxes imposed on petroleum products in India.
• Though it can’t completely denied that Oil Bonds do not affect the pricing of oil in today’s market.

What are the other factors causing high price of petroleum products in India?

• Around 80% of India’s petroleum requirements are fulfilled by imports, thus India plays a very little role in pricing of petroleum products in international market.
• The above therefore means that rise in fuel prices globally will lead to inflation of fuel prices in India too.
• Adding to this is the deregulation policy on fuel adopted by both Manmohan Singh and Narendra Modi government.

Deregulation Policy: It means that the retail price of fuel in India will be dictated by their actual price in the market with government providing very little to no subsidy.

• It must also be remembered that two year of economic slowdown due to Covid has forced has depleted the treasury of government and has made it impossible for to subsidise the fuel prices even if it wanted to.
• The taxes collected by the Union Government and state governments are major and reliable source of their revenue in the current scenario and help them to carry out their functioning including the implementation of welfare schemes.
• Value Added Tax (VAT) falls in the realm of state governments and is an important component of retail price of fuel. Hence, controlling the fuel prices completely is also not in the hands of the Union Government.
• The war in Ukraine has let to economic sanctions been applied on Russia, who is one of the major exporters of hydrocarbon globally, causing the skyrocketing of fuel prices.

What are the effects of high fuel prices on Indian Economy?

• It has to be remembered that petroleum products are non-substitutable imports and not buying them is out of question.
• Their high prices though severely impact the economy of India as a whole.
• Inflation in their cost leads to upswing of the input price of nearly all items of consumption and use.
• These leads to downfall of savings of the people of the country and that in turn negatively effects the capital available for investment in India.

How can the problem of high fuel prices can be solved?

• Providing subsidies is not a viable solution as it balloons the fiscal deficit of India.
• The above causes limited amount available with the government to be spend on welfare of the most economically marginalised communities.
• Increasing fiscal deficit also downgrade the investment ratings of India and therefore arrests the growth of Indian Economy.
• The Union Government therefore has to consider rolling back of taxes as the economy starts moving back to normal and sources of income get diversified.
• Government shall also focus its attention on developing alternatives to petroleum products which are ecologically friends, easily available and over the period time become less