A Seshan: Transparency on oil bonds

In order to compensate PSU oil marketing companies for the losses they are incurring due to the underpricing of their products, the government is in the process of issuing them Rs 11,257 crore worth of bonds. The oil companies had proposed that they be included in the list of approved securities which banks could buy for fulfilling their SLR requirements.

The government is not in favour of this as the bonds will compete with government securities under the market borrowing programme, and so the bonds are not as attractive as they may have been otherwise. In a regime of falling interest rates, the oil firms can sell the bonds with capital gains. This position changed after the central bank's measures to raise the cost of money. So, the oil firms have to bear the cost of the subsidy and their financial position gets worse with the capital losses sustained in the sale of bonds.

The question arises as to how the amounts involved in the bonds should be reckoned with while determining the revenue and fiscal deficits of the government and whether they would be covered by the targets under the Fiscal Responsibility and Budget Management Act (FRBMA). A senior official of the finance ministry once propounded the thesis that the oil bonds and the ones issued to the Food Corporation of India are in the nature of contingent liabilities. According to him, the FRBMA allows contingent liabilities of 0.5 per cent of the Gross Domestic Product and it would include the bonds.

The rationale behind considering the oil bonds as a form of contingent liability is not clear. A contingent liability is an indirect liability. As in the case of a guarantee, it becomes a direct liability if the principal performer or borrower fails to discharge his obligation. In the case of oil bonds, the government itself is the principal borrower. Its bonds to the oil companies are no different from any other security which it issues to the market to finance its deficit. It is a primary, and not a third, party in the transaction.

If the government had the money, it would have compensated the oil companies in cash and the transaction would have become an item of expenditure in the normal course. Oil bonds are a deferred liability like the unpaid liabilities or arrears of government payments to suppliers and contractors.

Thus, they should be treated as a liability of the government on par with the government's other borrowings with entries under the expenditure head. If banks buy bonds in the market, the net bank credit to the government would go up to that extent. That would not be the case if they constituted a contingent liability. The treatment of oil bonds helps in window-dressing the budget to meet FRBMA targets.

Government budgets are framed on the principle of cash, and not accrual, accounting "" the latter is followed only in the case of public enterprises. There is, of course, already a move towards the principle of accrual accounting in the budget. A stratagem often employed by the government to keep down the deficit at the end of the year is to postpone the payment of bills raised by suppliers, contractors and others to the next financial year. Thus, they are arrears of payment.

In retrospect, one wonders whether this was the reason for the extreme tightness in liquidity experienced by the banking system in the last quarter of 2005-06. It is very likely that, in order to rein in deficit, the government not only cut down expenditure, as reported in the press, but also delayed payments on its bills till the commencement of the next year resulting in the build-up of its balances in the RBI.

Once the new financial year started, the payments would have been released and the liquidity situation improved enormously to the point of a surplus in the system mopped up by the RBI through its reverse repo operations.

Despite all the claims on transparency, there are, however, no data available in the budget documents on the arrears of payments outstanding against the government at the end of the previous year. The RBI should clarify its stand on the treatment of oil bonds vis-à-vis fiscal and revenue deficits as they constitute a deferred liability.