Column : Their debt and ours

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: Apples and oranges should not be compared. Notwithstanding I am going to make such a comparison. I am going to focus this article on the links between the financial crisis in the West and the burgeoning debt position of the public sector oil companies IOC, BPCL and HPCL. I realise that by making such a comparison I could be accused of trivialising the former and exaggerating the latter. That is clearly not my intent. I know that the West has been hit by an unprecedented financial tsunami which has already reshaped the map of Wall Street and which may well redefine the ideological underpinnings of the capitalist system. I also know that by contrast the oil companies face no more than a localised downpour. Their exposure to Indian banks has grown alarmingly and their management must wonder how they will ever redeem this debt but the amounts involved do not at least for the present, pose a systemic risk. Were corrective steps taken now the financial consequence need be no worse than an uncomfortable drench.

I make the comparison because there are some similarities but more so because I want to draw attention to the potential consequences of our current petroleum product pricing policy.

The financial jargon of mortgage backed securities, collateralised debt obligations, credit default swaps etc tends to obscure a simple fact. The present crisis has occurred because the ‘Masters of the Universe’ in Wall Street forgot that the business cycle cannot be wished away through mathematical brilliance and financial sleight of hand. Markets do rise but they will also inevitably fall. There is no inexorable one way bet. They all got it horribly wrong.

The oil marketing companies can also trace their financial difficulties to a simple fundamental. The international suppliers of crude oil will not accept paper IOUs. They want hard cash. To meet this demand the companies have essentially two options. They can either generate the cash through internal operations or they can borrow from the banks. The government’s current product pricing policy has foreclosed the first option. The difference between the government mandated cap on the price of petrol, diesel, kerosene and LPG and the cost of manufacturing and marketing these products will, in FY 2008-09, result in an underrecovery (loss) for the companies of approximately Rs. 160,000 crore. The second option of borrowing has, therefore, been the only route. Under normal circumstances this too would have been closed. For banks do not or rather should not lend to fund losses. But these are not ‘normal’ conditions. The government cannot clearly allow the companies to run out of cash and so they have “persuaded” the public sector banks to make the loans. The three companies have reportedly ratcheted up borrowings in excess of Rs 100,000 crores.

Against the backdrop of the present financial crisis, certain questions must be asked. How will the loans be repaid? Who will pick up the tab in the event of default? What are the implications for the banks of such “subprime” lending?

I do not have the answers to these questions but two trends seem clear. First the companies will be hard-pressed to repay the banks. After all, they are not investing this money in productive assets. They are using it to remain operationally afloat. Second, the government will not allow the companies or banks to go under. It would come to their rescue if it ever seemed that the companies had come too close to the edge. This is the political reality. The question should be asked. What might be the implications of such “moral hazard”. Management know that they can do little to improve the finances of their company and they also know that the government will, in the ultimate analysis, cover their losses. Does this not create that recipe for increased risk taking? I know that the public sector is not known to be risk takers but still one should ponder the longer term consequences on the companies of managerial imprudence and nonchalance.

The one lesson that we can draw from the Western crisis is that the tax payer picks up the tab when people duck away from fundamentals.