Can oil bonds insulate Indian consumers from fuel price shocks?
With oil prices on the spiral, rising to $139 a barrel on March 8—the highest since 2008—India finds itself pushed to the corner. Since the country’s economy is heavily dependent on oil imports—about 80 per cent of our oil requirements are met by other nations—this is feared to dampen investor confidence considerably. Oil prices can turn economies, and governments. Oil prices were largely stable in 2020, but given the recent volatility, the Narendra Modi government faces the crucial test of managing the macroeconomic fundamentals, which are already under pressure after two difficult years of the Covid pandemic.
Price Uncertainties
Global oil prices have shot up by nearly 60 per cent in the last three months and raised grave concerns about growth and stagflation—simply put a scenario of muted growth and high inflation. There are apprehensions that a prolonged military conflict in Ukraine could take the price of Brent crude to $125 a barrel on a sustained basis. And in case oil imports from Russia are banned, Brent crude prices could even cross the $150 per barrel mark. Analysts at the Bank of America and JP Morgan say that cutting off Russian oil exports could cause a global oil shortfall of 5 million barrels or more a day. This could push prices to as high as $180-200 a barrel, which will invariably trigger a global recession.
Options for India
If the Ukraine war persists and Russian oil is not available, then India, like other world economies, will have to brace up for very high oil prices, nearly double of what was budgeted for. High oil prices will be inflationary, since India is the third biggest crude oil importer, and will put pressure on finances in the form of a higher fiscal and current account deficit and a weaker rupee.
The Union government has a few levers to deal with the spike in oil prices. Currently, excise duties, at Rs 22 per litre for petrol and Rs 28 per litre for diesel, are very high. The government can reduce this by Rs 10 and still be able to cover about 65-75 per cent of the total cost of oil, and it won’t be as inflationary. The other option is to pass on the price rise to consumers. But if oil prices continue to hover in the $130-140 a barrel range, these solutions won’t work. “Even if excise duty is down to zero, you cannot take care by wiping away the price hike. You cannot pass on the increase and cannot run down the oil marketing companies,” says S.C. Garg, former finance secretary. “In that case, one may need oil bonds.”
Are Oil Bonds the Solution?
Oil bonds were issued by the Congress-led UPA (United Progressive Alliance) government between 2005 and 2010 to insulate consumers from price shocks. They are issued by the government to compensate oil marketing companies for not passing on the higher costs to consumers. These were issued at the time when oil prices were not market linked but dictated by the government. The bonds could be redeemed at a later date by oil marketing companies, usually after 10-15 years.
There’s a catch, though. “There are massive downsides to oil bonds. They are a very bad instrument. They wreck the balance-sheets of oil marketing companies and only postpone the misery,” warns Garg. Moreover, the Modi government has in the past vehemently attacked the UPA regime for issuing oil bonds and citied them as a reason for the current government’s inability to lower oil prices for consumers. Clearly, there are no easy answers to the oil conundrum. For Indians, it’s time for some difficult choices ahead.
India Today
