THE Finance Ministry has for the third time in seven years issued oil bonds to honour its commitment to pay subsidy arrears to oil companies. This makes a mockery of fiscal responsibility and transparency.

It is not without any rhyme or reason that the Ministry excluded the terms ‘oil bonds' or ‘special bonds for oil companies' from the Fiscal Responsibility and Budget Management Act, 2003 and its rules. In the absence of clarity on this subject in the law, one can only surmise the oil bonds are deemed to be part of framework for guarantees that the Government can issue to subscribers of bonds issued by public sector undertakings, etc.

The Act limits the issue of guarantees to 0.5% of gross domestic product (GDP) in a year.

The issue of medium or long-tenure oil bonds helps the Ministry avoid its adverse impact on fiscal deficit in the year in which they are issued. The Ministry has to subsequently account for interest payable on these bonds in budget document. The real impact of such securities on the fiscal deficit is felt only in the year in which the principal is paid on maturity.

Why the Finance Ministry does not directly resort to market borrowings to raise cash to clear the overdues of oil companies and other entities? If it does so, then this would increase the fiscal deficit until and unless the impact of additional borrowings is offset through reduction in expenditure or through increase in revenue. The latter options are hard to try. Hence the easy recourse to good old oil bonds.

The Ministry has always treated oil bonds and the erstwhile oil pool account as items that can be kept outside the purview of fiscal discipline. This approach is reflected in the explanatory note to the Budget at Glance for 1998-99, the year in which it issued maiden oil bonds to seven public sector oil companies for amounts aggregating to Rs 12984 crore.

The explanatory note says: “Certain transactions which do not involve cash outgo, e.g., ways & means advances to States,.., issue of special bonds to oil companies in lieu of their claims under the administered price mechanism (APM) for petroleum products, which are matched by receipts, have been excluded so that the focus is on real items of expenditure.”

In that year, the Finance Ministry had issued “10.5% oil companies' (non-transferable) Government of India Special Bonds, 2005.” As the title of the securities suggest, they carried annual interest of 10.5% and matured for redemption in 2005. As they were not transferable, the oil companies could only use them as collateral to raise additional borrowings from the banks.

The Government was forced to issue these bonds as the erstwhile oil pool account (OPA) remained in deficit for many years and the deficit had touched Rs 14,156 crore in 1997-98. The Petroleum Ministry had maintained OPA to collect surplus profits from some companies and to pay those that earned lesser profit under APM that provided for 15% post-tax return to exploration and production companies and 12% to refining and market companies. OPA also provided for pooling of the prices of imported and indigenous crude oil and refinery products.

OPA was created in 1974 to cope with the first oil price shock and to stabilize retail prices. Its abolition on 31 March 2002 was supposed to herald full-fledged market-driven pricing of petroleum products. The unabated rise in global prices of crude, coupled with lack of political will to allow import-parity pricing, reduced dismantling of APM to a sham.

When the Government scrapped OPA, it decided to clear immediately all outstanding claims of oil companies upto Rs 9000 crore by issuing “6.96% oil companies' Government of India Special Bonds, 2009.” It had stated the balance arrears would be paid by the Government after certification of the accounts by Comptroller and Auditor General (CAG).

When OPA was wound up, the fiscal purists hoped that one dark chapter in the management of extra-budgetary funds has been closed. This hope proved short-lived on 6 September 2005 when the Cabinet decided to issue bonds to oil marketing companies to partly liquidate their overdue payments.

Before going into details about the latest bond issue, it is pertinent to recall the observations made by Reserve Bank of India's Advisory Group on Fiscal Transparency (AGFT) in its report in 2001.

AGFT said: “The most important extra-budgetary arrangement which has a significant fiscal impact but which is not included in the budget is the Oil Pool Account operated by the Oil Coordination Committee…. It is difficult to determine whether this is an extra-budgetary fund or a form of quasi-fiscal activity (QFA).”

Taking note of Government's move to abolish OPA and liquidate its deficit through issue of special bonds to oil companies, the committee recommended that “if oil pool account is not abolished for any reason, the deficit incurred on this account should be reported in budget documents in the interest of transparency.”

The Finance Ministry must take the public into confidence by disclosing as to how the need for issue of oil bonds post-OPA abolition arose. It should disclose how much subsidy is required for liquefied petroleum gas (LPG) and kerosene for household use only and how much it allocated in the budget. It ought to disclose the revenue stream that is contributing to this subsidy allocation.

The Ministry also must disclose in the budget document the losses incurred by oil marketing companies due to retailing of petrol and diesel below the international prices. Do the latest oil bonds constitute part compensation for such losses or part compensation for under-provisioning of the budgetary LPG & kerosene subsidy?

The Ministry's notification dated 9 September on 7% oil companies' Government of India Special Bonds, 2012, is silent on such issues of grave concern to public. These bonds are transferable unlike the ones issued in 1998.

The notification says that these special bonds cannot be considered as eligible investments in government securities by financial institutions or any other entity towards fulfillment of any statutory requirement applicable to them.

The Ministry should explain as to why the booming reveneue from ad valorem imposition of excise and customs duties on petroleum sector could not be used to mitigate the miseries of oil companies.

The emergence of oil bonds and the losses incurred by oil companies should be viewed as complete failure of pricing reforms in petroleum sector. They also constitute a telling commentary on budgetary reforms.

The oil companies can draw solace from the fact that at least they periodically get bonds against which they can raise fresh debt. The fertilizer companies have to live with carry-over of subsidy arrears by the Government to the next year's budget year after year. The fertilizer companies offset the resulting liquidity crunch by raising additional working capital from banks.

It would be interesting to investigate how the Government keeps the fiscal deficit under check in a year by spilling over its payment obligations to the next year and rolling some of them year after year.

Will CAG and/or Parliament's Standing Committee on Finance institute suo moto investigation into Finance Ministry's budgetary and fiscal malpractices?