What are oil bonds and how do they affect the Government's decision

• Over the last year, as retail prices of petrol, diesel and other petroleum products have surged, the government has attracted criticism.
• On several occasions, Finance Minister countered such criticism by claiming that the current government cannot bring down taxes because it has to pay for the oil bonds issued by the Congress-led UPA government.

What are 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.
• 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.
• An oil bond is an IOU, or a promissory note issued by the government to the OMCs, in lieu of cash that the government would have given them so that these companies don’t charge the public the full price of fuel.
• 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 straight away, the government will pay it, say, 8% (or Rs 80 crore) each year until the bond matures.
• Thus, by issuing such oil bonds, the government of the day is able to subsidise the consumers without either ruining the profitability of the OMC or running a huge budget deficit itself.
• Oil bonds were issued by several governments in the past. But the ones in question now are the ones that the UPA government issued.

Why do governments issue such bonds?

• Compensation to OMCs through bonds is 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.

History of fuel deregulation policies

• The central government gradually deregulated fuel pricing:
• Dropping rates for-
  • Aviation turbine fuel in 2002
  • Gasoline in 2010
  • Diesel in 2014
• Previously, the government would interfere in determining the price at which dealers would supply diesel or petrol.
• As a result, oil marketing companies (OMCs) suffered under-recoveries, that the central government had to make up for.
• Rates were deregulated in order to implement them as market-linked, relieve the government of the responsibility of subsidising prices, and help buyers to profit from reduced prices whenever global oil prices fall.
• Price deregulation effectively allows fuel merchants to set their own pricing based on their own cost and profit assessments.
• The government benefits the most from this reform of price control.

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

• Total payout was just 7% of the total revenues in 2014-15. As the years progressed, this percentage has come down because taxes generated from this sector have soared.
• The total revenue earned by the government (both Centre and states) between 2014 and 2022 from taxing petroleum products is more than Rs 43 lakh crore.
• That means the total payout by the NDA government to date on account of oil bonds is just 2.2% of the total revenues earned during this period.
• While the NDA government has had to pay for oil bonds, the payout is not big compared to revenues earned in this sector.

Impact

• While oil price deregulation was meant to be linked to global crude prices, Indian consumers have not benefited from a fall in global prices.
• The central, as well as state governments, impose fresh taxes and levies to raise extra revenues.
• This forces the consumer to either pay what she’s already paying or even more.
• Issuing bonds pushes the liability to a future generation.
• But to a great extent, most of the government’s borrowing is in the form of bonds. This is why each year the fiscal deficit is so keenly tracked.

Exam track

Prelims take away

• Oil bonds
• Oil price deregulation

Mains take away

Q. What are oil bonds, and to what extent do they tie the government’s hand in taking decisions?