Oil bonds as bad as recapitalisation bonds

When Union Finance Minister Nirmala Sitharaman was asked why the excise duty on fuels like petrol and diesel remained high, with the price paid by the consumer rising inordinately, she refused to lower the duties. Instead, she passed the blame on to the previous governments, pointing a finger at the earlier UPA regime.

It was the oil bonds issued earlier which were the villain of the piece, she averred. If those bonds did not have to be serviced (their principal and interest accrued repaid), then she could have reduced the excise duty. “I am paying through my nose for the oil bonds,” she asserted somewhat dramatically.

She is right but not quite fair. Oil bonds are only half the story. In 2017, the NDA government, when Arun Jaitley was the Finance Minister, committed the same sin, of issuing the PSB (public sector banks) recapitalisation bonds. Subsequent governments will have to pay for them through their nose as the present government is doing on account of the oil bonds. Sitharaman has lost the moral high ground that she was seeking on account of the oil bonds because of the recapitalisation bonds.

Now details of the two-part story. The oil bonds were issued between 2004 and 2011 during the time when fuel prices were controlled in order to prevent the burden of the then prevailing sky high global fuel prices (crossing $100 per barrel) falling on the shoulders of the consumers. The oil marketing companies had to be compensated for the losses they were suffering on account of their government-dictated low selling prices. The government had, till then, been doing this by simply paying them out of the exchequer, which raised the budget and the fiscal deficit.

Then the government devised a way of eating the cake and having it too. It would reimburse the oil companies and not raise its deficits by issuing them bonds, essentially IOUs. The companies would monetise these and recoup their cash losses. But the government, at a later date, would have to foot the bill — pay the interest that accrued on the bonds, and eventually, retire them on maturity by repaying the principal sum it had borrowed. On the Rs 1.3 lakh crore oil bonds that were issued, the interest payments would stretch from 2007 till 2026 and the principal would mainly be repaid during 2024-26.

Now let us turn to 2017. The then Finance Minister Arun Jaitley had to pump fresh equity into the public sector banks as their equity had fallen below the minimum prescribed by the Reserve Bank of India to go on functioning. The banks had to write off their books, rising levels of bad debt by adjusting them against the capital held.

But instead of subscribing to fresh capital of the banks by paying out of its own revenue, the NDA government issued over Rs 2.5 lakh crore of bank recapitalisation bonds. For this, right now, the present government is paying annually an interest of Rs 19,000 crore (twice what it is paying for the oil bonds) and the principal repayment will stretch till 2034.

Now let us come back to the issue of current high fuel prices made so because, as the government has said, it has to service the oil bonds issued by the earlier government. But here comes a big catch. The Rs 10,000 crore being paid by the government on oil bonds is much smaller than what the government makes cumulatively through fuel excise duties. So, the whole truth of the matter is that the government is levying high fuel prices in order to not just be able to service the oil bonds but also to raise additional revenue.

So, raising enough revenue in order to keep the budget and fiscal deficits low is sacrosanct, isn’t it? Well, not quite! Despite the need for revenue, the government had cut excise duties on fuel during 2017 and 2018, before the Assembly elections.

Well, the villain of the piece then is the need for the Central Government to raise enough revenue, isn’t it? Yes and no. There is one other villain. The state governments also make good money out of fuel taxes, both as their share of divisible revenue and state VAT, but the Centre makes much more. How? Partly through the device of declaring some imports as cess, whose proceeds do not have to be shared with the states.

Before the fuel prices were decontrolled, they would be kept low for consumers by government fiat and the deficits (under-recoveries) booked by the oil marketing companies were compensated by the government through payments from general revenues. The government would get a respite when the global oil prices went low and oil marketing companies did not book a deficit.

Under the present system, when consumers pay high fuel prices because of high global prices, they should get a respite when prices run low. But that has not happened. Last year, the excise duty was hiked by over 50 per cent to mop up the space opened up when international oil prices fell sharply as demand dropped, owing to the pandemic-induced lockdowns across the world. This gave the government a revenue bonanza.

Now let us look at the actual mechanism the government uses to handle the recapitalisation bonds so that its fiscal deficit is not affected. Banks set to receive the bonds are asked to buy them on issue. As soon as the government receives the proceeds, it uses them to inject fresh capital into the banks. So, at that moment, there is no movement of revenue on the government’s books. Then, as and when interest and principal payment on the bonds become due, they are paid out of the government’s coffers.

By issuing bonds, the governments are postponing a revenue outgo by using an accounting device. When the payment date finally comes, it will have to be made. But when the bond issue decision is taken, that date is far away and politicians who cannot look beyond the next elections pass the burden on to the government of the future, whoever it may be.