Oil Bonds

Oil Bonds

Subject: Economy

Section: Fiscal policy

Context:

The Finance Minister has said the government cannot bring down taxes – and thus oil prices – because it has to pay for oil bonds issued by the UPA.

From 2015 to 2021, the government has fully paid off four sets of oil bonds — a total of Rs 13,500 crore. As of March 31, 2021, there was Rs 1.31 trillion in outstanding principal and Rs 37,340 crore in interest yet to be repaid on these oil bonds, she said.

Concept:

How much of fuel prices is tax?

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

Oil bonds:

Previously, Petrol and diesel prices were fixed by the government to cushion consumers from price shocks and if crude oil prices were high, oil refining and marketing companies would technically sell petrol and diesel at retail outlets at a loss. The government, however, compensated oil companies by issuing long-term bonds that they could redeem later. Thus, these bonds are, in essence, promissory notes of deferred payment of subsidies that the government owes to OMCs.

An oil bond is an IOU, or a promissory note issued by the government to the Oil Marketing Companies (OMCs), in lieu of cash the government would have given them so that these companies don’t charge the public the full price of fuel.

There are two components of oil bonds that need to be paid off:

• the annual interest payment, and
• the final payment at the end of the bond’s tenure.

By issuing such bonds, a government can defer the full payment by 5 or 10 or 20 years, and in the interim just pay the interest costs.

For example- 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.

Purpose:

Thus, 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.

Conclusion:

Issuing bonds pushes the liability on the future generation. But to a great extent, most of the government’s borrowing is in the form of bonds. However some measures should be taken while issuing bonds:

• The fiscal deficit (which is essentially the level of government’s borrowing from the market) should be  keenly tracked
• The main wisdom while issuing bonds is for a government to employ this tool towards increasing the productive capacity of the economy.