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A. Seshan

The oil marketing companies (OMCs) in the public sector are facing great difficulties due to the enormous rise in the prices of their imports, which they are not able to pass on to consumers due to the restrictions placed on them by the Government. International crude prices have touched $135 a barrel with losses of the companies threatening to reach Rs 2,25,000 crore, according to the Petroleum Minister.

Alarms have already been raised by some of them that they are facing serious cash flow problems. They will have to approach banks for further accommodation as they are likely to run out of cash for crude purchases in a few months. How far banks can oblige them, given their prudential considerations, is a matter to be reckoned with. In a similar situation, private sector companies will not be considered favourably by banks for any enhancement in borrowing limits.

Although the expansion of credit has been somewhat subdued so far this year, there could be a change in the situation given the lagged impact of inflation on manufacturing costs and the acceleration of expenditure on projects and schemes in the public sector in view of the general elections ahead.

Since there is no longer the inflow of foreign capital on a scale witnessed in the last year, there could be a real stringency in credit in the months ahead.

Thus, the Government will have to bring pressure on the public sector banks to enhance the credit limits of oil companies.

This will be in line with the tradition of directed credit despite the so-called liberalisation of the banking sector.

There is now a close parallel to what obtained during the Gulf War crisis of the early 1990s. Then the country’s forex kitty had run dry with the reserves being enough to finance hardly a fortnight’s imports at one point of time. Oil imports were financed by rolling over of overnight credits in the New York money market.

Today, the oil companies are in a similar situation of paucity of funds with a difference. We have plenty of forex. But the companies are short of rupee resources! The problem is in making the banks agree to fund them when their finances are in a bad shape.

The Reserve Bank of India (RBI) has made it possible for banks to lend more by modifying its regulation regarding exposures to the oil companies. The Government is considering various options to alleviate their distress. But it is clear that whatever relief the companies get will only be partial.

Full pass-through is just impossible in an election year, especially with inflation on the rise. Periodical rollover of credit to the oil firms may become necessary, a la the Ponzi Game. It would create problems for banks in complying with the Basel standards.

A solution can be found on the following lines. The oil bonds issued by the Government to compensate the companies for under-recoveries in sales may be included in the securities approved for investment by banks for complying with the Statutory Liquidity Ratio (SLR). This will make them marketable.

Now, because of their non-SLR status, they are not looked at favourably by banks. To raise cash to meet the immediate needs, oil companies are forced to sell them at a discount, incurring further losses. It is a double whammy for them.

The Government’s fear is that SLR status will make the oil bonds compete with its market borrowings. This constraint can be overcome by raising the SLR from 25 per cent of deposit liabilities to a higher percentage, appropriately worked out, so that there is room for both types of bonds to co-exist.

In any case, SLR ratio may have to be raised due to the additional commitments taken by government after the presentation of the budget, necessitating an increase in market borrowings proposed therein.

Since sales of securities are made under auction, banks can take care of their yields, unlike the case in the pre-reform days, when they had to finance government at stipulated rates lower than what prevailed in the market. The only party to suffer will be government because its interest liabilities will go up in market borrowings. But, then, that is the price it has to pay for its poor financial management. The targets under the Fiscal Responsibility and Budget Management Act need to be suspended for some time, for which there is an enabling provision in the legislation.

The Food Corporation of India and the fertiliser sector are the others that have received large amounts of government bonds by way of compensation for their subsidised sales. But they do not seem to be in the same serious financial situation as oil companies. The extension of SLR status to their bonds need not be considered at this time.

On May 30, the RBI announced two important measures as Special Market Operations to deal with the oil crisis:

to conduct open market operations (OMO) (outright or repo at the discretion of the Reserve Bank) in the secondary market through designated banks in oil bonds held by public sector OMCs in their own accounts subject to an overall ceiling of Rs 1,000 crore on any single day; and

to provide equivalent foreign exchange through designated banks at market exchange rates to the companies.

These decisions have important implications for the markets. The sale of forex reserves would obviously help in arresting the depreciation of the rupee against the dollar.

The dollar purchases of oil companies to pay for imports constitute an important element in the forex markets, moving them in a substantial manner. The outright purchase or repo operations by RBI would facilitate the companies in raising funds. One hopes the RBI will give the oil firms a better deal in pricing their bonds than the banks. In such an eventuality, companies will find it preferable to dispose of the bonds to meet their immediate cash needs rather than raise repos at 7.75 per cent.

The sale of forex is also an OMO in terms of its impact on money supply. The daily limit of Rs 1,000 crore may be availed of by oil firms continuously so that, over a month, the total amount would be substantial. In view of the emerging credit stringency, the RBI will have to fine-tune its two operations mentioned above in such a way that the money absorbed from the system by the sale of forex is injected back through outright bond purchases or repos.

It is tantamount to a forex-for-bonds swap. This is the first time the central bank would be doing OMO in non-SLR securities. But will the RBI be able to return the purchased bonds to the system? It is doubtful, given the non-SLR status of the bonds.

In this connection, the suggestion to accord them SLR status and raising the SLR ratio would better achieve the purpose of two-way transactions in bonds. Banks would also then prefer to invest in oil bonds rather than lend to OMCs given the latter’s poor financial state. It would be helpful from the prudential point of view too.

More Stories on : Petroleum | Corporate Bonds

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