Oil bonds are issued by the government to compensate OMCs to offset losses that they suffer to shield consumers from rising crude prices.
These bonds do not qualify as statutory liquidity ratio securities, making them less liquid when compared to other government securities.
Oil bonds in news
Finance Minister Nirmala Sitharaman on August 16, 2021 said that the government is paying off dues to oil marketing companies (OMCs) for oil bonds that the Manmohan Singh-led UPA government had issued.
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.
Why were these bonds issued?
These bonds were issued to OMCs by India between 2005 and 2010 in lieu of cash at a time when the government used to fix fuel prices. Petrol and diesel prices were fixed by the government to cushion consumers from price shocks.
Previously, 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.
High crude prices and the blowback from the 2008 recession increased the pressure on the government. By raising capital through bonds, these payments could be made in a deferred manner without causing a major escalation in prices.
These bonds are, in essence, promissory notes of deferred payment of subsidies that the government owes to OMCs. Since the government did not subsidise these companies, these payouts did not show up in budget documents, until the repayment of the principal or interest components took place.
These off-Budget items, therefore, did not show up in the fiscal deficit numbers during the annual Budget and only started factoring these when the repayment of these bonds started to take place years later after issuance.
When were oil prices deregulated?
The first step towards deregulation was taken in 2010 with the announcement that oil bonds will be discontinued, and OMCs will be paid in cash.
In June 2010, petrol prices were deregulated, mirroring the market price of crude. The government freed diesel prices in October 2014. In June 2017, India adopted the system of dynamic fuel pricing where the retail price of petrol and diesel fluctuate on a daily basis.