Concept of Oil Bonds

Context: Recently, 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 UPA government to subsidise fuel prices.

• In this context, we discuss about Oil bonds and Rationale behind issuing such bonds by the government.

Background

• Fuel price decontrol has been a step-by-step exercise, with the government freeing up prices of aviation turbine fuel in 2002, petrol in 2010, and diesel in 2014.
• Prior to that, the government would intervene in fixing the price at which retailers were to sell diesel or petrol.
• This led to under-recoveries for oil marketing companies, which the government had to compensate for.

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.

• 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.

About Oil Bonds

• Oil bonds are special securities issued by the government to oil marketing companies in lieu of cash subsidy.
• These bonds are typical of a long-term tenure like 15-20 years and oil companies are paid interest.
• Before the complete deregulation of petrol and diesel prices, oil marketing companies were faced with a huge financial burden as the selling price of petrol and diesel in India was lower than the international market price.
• This ‘under-recovery is typically compensated through fuel subsidies allocated in the Union budget.
• However, between 2005 and 2010, the UPA government issued oil bonds to the companies amounting to Rs 1.4 lakh crore to compensate them for these losses.

Why do governments issue such bonds?

• 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 that lead to a collapse in revenues or a surge in expenditure.
• These types of bonds are considered to be ‘below the line’ expenditure in the Union budget and do not have a bearing on that year’s fiscal deficit, but they do increase the government’s overall debt.
• However, interest payments and repayment of these bonds become a part of the fiscal deficit calculations in future years.

But, this approach does have its negative implications

• 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.
• On future fiscal deficit calculations: Interest payments and repayment of these bonds become a part of the fiscal deficit calculations in future years.
• 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.

Road Ahead

• 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.