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June 02, 2008 10:24 IST
The quarterly and annual results of the Indian Oil Corporation [Get Quote] (IOC), which were declared last week, brought into sharp focus what everybody already knew.
Oil marketing companies are bleeding to death as a result of the government's inability to raise retail prices to accommodate the huge increases in the international price of crude oil.
While the gap has been notionally covered by the issue of oil bonds to these companies, the real constraint is cash; the companies obviously cannot use the oil bonds to pay their crude suppliers!
The chairman of IOC raised the red flag when he said that the company might have to begin curtailing imports because of this constraint, resulting in reduced supplies to domestic consumers. IOC's situation is undoubtedly shared by the other two companies, Bharat Petroleum and Hindustan Petroleum, both of which are listed on stock exchanges. The current situation clearly makes their stocks terribly unattractive.
The spectre of queues forming at petrol pumps goaded the government into considering some concrete steps over the past few days, but a resolution has yet to emerge.Meanwhile, the Reserve Bank of India [Get Quote] stepped in to staunch the flow with a couple of measures. It has increased the borrowing limits of the oil companies, easing their cash constraint.
It has also permitted banks to treat the oil bonds as normal government securities, which increases the liquidity of the bonds and further helps the companies to raise cash. However, as legitimate as these measures may be, they merely address the symptoms and that too from a short-term perspective. Borrowing limits cannot be raised beyond a point, while an endless supply of oil bonds will simply raise the desired yield on them and make raising funds through them more costly.
The measures may have bought the petroleum sector a little time, but that is all they can do. There simply is no alternative to a policy response, which addresses the root cause of the problem. This means that, whatever else the government may do to mitigate its impact, the response has to be based on an increase in retail prices. This may be staggered, but each hike cannot be insubstantial. Even a partial adjustment must be large enough to simultaneously shore up the financial condition of the oil companies and induce consumers to use less oil.
Impact mitigation may come in the form of reduced Customs duties on crude oil, but this is already quite low and, even if it is eliminated, will be far from offsetting the price increase. It will, further, aggravate an already deteriorating fiscal situation. It is in this context that the proposed cess on income tax needs to be viewed. At best, it can compensate the government for revenues lost in eliminating the Customs duties on crude oil and petroleum products. If compensation is the objective, there are probably more efficient ways to do it than imposing higher taxes on companies and individuals in a decelerating economy.
The first thing that comes to mind is privatisation. The government can surely raise enough resources through strategic sales of equity in public enterprises (other than the oil companies!) to both offset the revenue loss and redeem some proportion of the outstanding oil bonds. Of course, time is of the essence; a combination of immediate and more time-consuming solutions may be the best bet.
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