The government has been mulling over giving statutory liquidity ratio (SLR) status to the oil bonds it issued in the past. While the move, assuming it gets consent, has been hailed by both oil companies as well as banks because it will widen the government debt market with longer dated securities of over ten years, the moot question that bugs industry players is how long will successive governments refrain from instilling a ?real? free pricing mechanism for petroleum products.
SLR bond status to PSU oil bonds would be similar to a pacifier given to a wailing baby. PSU oil companies would no doubt take a hit of at least 50 bps by way of coupon if their bonds become tradable under SLR. Yet they don?t seem to have a problem because of the high liquid nature if these bonds come under SLR. Currently the coupons range between 8.5% to 9.5%. They give immediate relief to PSUs by way of liquidity induced by participation of bigger players like banks, gilts and mutual funds, apart from existing pension, provident fund and insurance players that trade less and hold on to the papers till maturity.
Bonds that typically come under SLR, or statutory liquidity obligation, also form part of the fiscal deficit and in this case, whether the government would like to show it as part of its borrowing remains to be seen as this would give an immediate bulge to the fiscal deficit by almost Rs 1 lakh crore. SLR bonds are those issued by the government at market rates to fund its various borrowing activities every year. Banks are required to subscribe to them, as they are mandatory requirement stipulated by the Reserve Bank of India. Currently, banks maintain 25% of their net demand and time liabilities in SLR.
The bonds are highly secured and liquid in nature as they are sovereign guaranteed. Given this nature on the one hand and the illiquid structure of other government bonds that do not qualify for SLR, in this case the oil bonds, the thought process, at least in this case, of the government appears to be in the right direction. For one, with the robust economic growth, which was at over 9% in the last two consecutive years, has also seen, for the first time, indirect tax collections overtaking direct taxes.
But what successive governments have refrained from acting on is the free pricing mechanism for oil. The loss on account of subsidized fuel pricing by government oil companies that dominate 95% of the market share is sending jitters among economists and other thinkers.
By not pegging retail fuel prices to market price, the government has artificially suppressed inflation to below 5%. Even the Reserve Bank of India, at several forums, has conceded that the entire pass-through effect of the oil price increase has not taken place, and the inflation levels today are not fully reflected.
The main reason to issue oil bonds was to offset the subsidy given to oil marketing companies for retailing commodities like kerosene, LPG, petrol and diesel at below market prices. Under-recoveries, as a result, have been huge. For the current fiscal till now, the under-recoveries have been close to Rs 72,000 crore.
Even though in theory free-pricing is permissible, the reluctance by the owner, the government of India, in not letting PSU oil companies link retail rates to global oil price movements, is becoming a burden on tax payers. Private players have no say in a market that is dominated by PSU oil companies that enjoy a 95% market share.
For every Rs 50 one pays for a litre of petrol in mega cities like Mumbai, over 55 % goes towards various central and state government taxes. Of the total Rs 1.56 lakh crore earnedin revenues during fiscal 2006-07 by state governments and the Centre, excise duty was Rs 52,000 crore of which petrol and diesel contributed nearly 70%. For state governments, revenues were Rs 62,000 crore, of which state sales taxes were Rs 56,000 crore. It therefore makes economic sense for governments to allow PSU oil companies to take a temporary hit citing inflationary pressures and later issue bonds to the ?crying babies?.
Even the Prime Minister, Manmohan Singh, in the past, acknowledged that such subsidization of petroleum products was not sustainable and that there were limits to the extent which the government could go to insulate people from the effects of rising oil prices. The viewpoint echoes what oil company officials have been suggesting to successive governments in the past.
?How can preventing a rise in petro-product prices guard a common person from the effects of consumer-linked inflation when the public distribution system itself is faulty?? asked a top official at a government oil marketing company.
The fact that oil bonds were issued because of the hit PSU oil firms took on account of selling products below cost price, is now becoming questionable even by opposition political parties.
The market situation is such that private players too take a bigger hit because they don?t get subsidy bonds.
With the recent hike in petrol by Rs 2 and a Re 1 per litre of petrol and crude respectively, the government?s share of meeting under-recoveries through oil bonds is now 57% from the earlier 42.7%, with another 33% of balance coming from upstream oil companies like ONGC and Gail (India), 2% from oil marketing government companies, while 8% forms under-recoveries.
Even at the revised rate, the petrol retail price is about Rs 6 below the cost price and for diesel by another Rs 3.
According to industry estimates over one crore of the deserving population are out of the purview of food security or PDS. The question therefore arises is whether subsidies are effectively directed towards the deserving class of population.
If curtailing transportation costs to check inflationary pressure is the case, another estimate has pegged the total essential food-goods transported across the country is currently around 10-15%. Would this be cause enough for governments to keep the subsidies going for petro-products, especially when 85% of the goods comprise of non-food commodities like cement, steel, commercial vehicles etc. More flak gets drawn when under recoveries, this fiscal, have been to the tune of Rs 72,000 crore.
PSU officials argue, if there is a political consensus to ensure the masses are benefited, the government should exercise its option of issuing coupons or smart cards that would ensure that subsidies reach the deserving class. They opine this would cap the wastage to less than a third the current outstandings in under recoveries and the country would still be in a much better position than what it is currently.