Friday, December 26, 2008

The Worry of Oil Bonds

In 2008, the Government of India issued oil bond worth billions of dollars to compensate state-run Oil Marketing Companies (OMCs) for the huge losses they incurred in subsidising oil sold in India. This system is dangerous and will have major ramifications in the future.

Bonds are a most ingenious financial instrument: they're counted as debt, but only in the future. Bonds need not be mentioned in the current account deficit or as expenditure. This creates an illusion of a Government that is extremely fiscally responsible. Such an illusion if false.

When the time comes for the Government of the day to redeem these oil bonds, the cat will come flying out of the bag. The Government cannot default on these bonds, it has to find some way to get the money to repay them. Now, one way would be to boost exports and use the earnings to pay them back. But with the ever-widening trade deficit, that seems highly unlikely. The other way is to sell off State-owned assets. While that could happen, there will be huge opposition to it, and it will take a very brave (and numerically strong) government indeed to go ahead with it. If the Left ever comes to power, that can be ruled out entirely.

Then there is the option of raising taxes. That seems to be exactly what the Government will be doing. While we drive our fuel-inefficient cars to work, ignoring public transport and our own two feet, we are being bolstered by cheap fuel, all subsidised. What worries me the most is that this indulgence will hurt future generations. They (we) will have to pay more in taxes, consumption will be dragged down and the economy will follow. That's the dangerous future being gifted to us by the UPA.

The solution however, is complex. There is no question of lifting oil subsidies: both from a political and moral point of view, it is wrong. Political, because it would anger the masses who, sadly, think the Government can simply print money without worrying about it. Moral, because most people in India live below the poverty line and cannot afford the Kerosene required to cook. There is however, a middle path: differential subsidies.

The current policy of the Government is to issue blanket subsidies on oil products: that means everyone from the local farmer to Mukesh Ambani use subsidise fuel. While the poor really need it, those earning several lakhs a year do not. And that's where the political courage comes in: to remove subsidies, wholly or in part, to higher income groups. They can afford it, and if they can't, they can at least afford a bus ticket. If they want the luxury of a car, they must be ready to pay for it; that's a basic tenet of capitalism. However, those making just enough money to survive cannot afford even a bus ticket and need subsidies to stay alive. It would be inhuman to lift subsidies on them.

You can play around with everything except the economy. If you try to mess with the economy, it will come back to bite you. The danger of creating too much debt and praying to God to make the next generation pay it off is huge. It will take some visionary steps to correct our course. The Congress in 1991 made such bold decisions. Sadly, the UPA is not the Congress of 1991.

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