Oil bonds to drive up interest burden

MUMBAI: India’s fiscal policy managers and the political establishment are now adept at postponing present day problems, leaving it to their successors to handle the mess a few years down the line.

This is best reflected in the issuance of bonds to cash-strapped oil companies, utilities in the power sector and the famous case of tax-free bonds to investors who had bought units of US-64 of UTI, once the country’s top fund house.

By issuing bonds, the government of the day can live to survive when it comes to handling a liquidity problem faced by entities on account of pricing restrictions. Instead, the buck is passed on to a future government to service and redeem such large scale liabilities.

As oil prices surge to record highs, which touched a high of $78 on Friday, it is a sense of deja vu. For, the government is all set to try out that time-tested tactic of bond issuance again.

This fiscal, the government plans to issue oil bonds aggregating Rs 28,000 crore to local state-owned oil companies to help them tide over the losses incurred on account of selling products such as LPG and kerosene at prices well below their production cost.

The first tranche of oil bonds of over Rs 6,500 crore for this quarter is expected to be issued after the government finalises the quantum and the details later this month. By then, the colour of the balance sheet of oil companies could be different.

For oil companies, these bonds, if assigned a status of tradeability, can be sold down to generate cash and obviate a liquidity crunch. Otherwise, these bonds can be used as collateral to raise cash. These bonds are generally issued for maturities ranging from 5-7 years.

The issuer, the government, has to bother about redeeming those bonds only after five years. In the year of maturity, the government has to arrange for a substantial cash outgo to redeem such bonds. In one way, it is as good as cash infusion for these companies.

But from the perspective of the fisc, the interest outgo on these bonds will annually count in determining the fiscal deficit. With interest rates on the upswing, the outgo is not something which the government can be blase about. Not just that, the issuance of these bonds could impact the government’s own borrowings.

For, when such bonds are issued to oil companies, which then attempt to sell them down, the government may well be competing for its own borrowing with a limited investor segment. This could end up putting upward pressure on rates.

Much was promised when the old administered price mechanism (APM) was dismantled in ‘02. Subsequent to that there was the promise of oil refiners being given the freedom to price their products every fortnight. At the time of dismantling, it was decided that 80% of the outstandings would be paid with 20% to be settled later after an audit was completed. Bonds were issued after that.