High Fuel Prices and Oil Bonds - Vivek Kaul

Explained: Why the Govt is Misleading Us on High Fuel Prices and Oil Bonds

The reason why doesn’t matter. The only thing that matters is controlling the narrative – Fabian Nicieza in Suburban Dicks.

Over the last few years, several government ministers have blamed the oil bonds issued during the era of the previous United Progressive Alliance (UPA) government, for the high petrol and diesel prices, which have prevailed for a while now.

The then oil minister Dharmendra Pradhan had tweeted in 2018 that: “The country and our OMCs [oil marketing companies} are also yet to recover from the shock of Oil Bonds worth Rs 1.4 Lakh Crores issued during the UPA regime.”

The finance minister Nirmala Sitharaman rblamed the oil bonds for the high prices of petrol and diesel, in a recent statement. This is not true. I have explained this issue in great detail on earlier occasions. Nevertheless, I will try and offer a broader summary here, before getting on to the new points I want to make.

Oil bonds were largely issued by the previous UPA government. This was done in order to compensate oil marketing companies, like Indian Oil, Bharat Petroleum and Hindustan Petroleum, for selling petrol, diesel, kerosene and domestic cooking gas, at a price which wasn’t monetarily feasible for them.

The argument offered by the National Democratic Alliance (NDA) government is that since interest has to be paid on these bonds and that these bonds have to be repaid, the government needs to charge a high excise duty on petrol and diesel. This leads to high petrol and diesel prices.

In that sense, the NDA government and you and me are paying for the sins of the UPA government. This argument is never made in as clear words as I am making it here. Things are left vague enough for people to fill in the gaps and make their own WhatsApp forwards.

As of March 2014, before the NDA government came to power, the total oil bonds outstanding stood at Rs 1,34,423 crore. By March 2015, this had come down to Rs 1,30,923 crore, which is where it has stayed up until March 2021.

This means that between end March 2015 and end March 2021, no oil bonds matured and hence, the NDA government didn’t need to repay a single rupee of oil bonds. Of course, interest had to be paid on these bonds. An interest of Rs 9,990 crore has to be paid on these bonds every year. This means, over a period of six years, between end March 2015 and end March 2021, the government has paid Rs 59,940 crore as interest on these bonds.

During the same period, it earned Rs 14,60,036 crore as excise duty on petroleum products. As the government told the Lok Sabha in early August this year: “Central excise duty is contributed largely by Petrol and Diesel.” So, excise duty earned on the sale of petrol and diesel makes up for a bulk of the excise duty earned on sale of petroleum products.

In total, during this period, 4.1% of the excise duty collected on petroleum products has gone towards paying interest on oil bonds. In 2020-21, this stood at just 2.7% (Rs 9,990 crore of interest against excise duty of Rs 3,71,726 crore earned on petroleum products).

In fact, if were to look at excise duty collected on just petrol and diesel, between end March 2015 and end March 2021, it amounts to around Rs 13.7 lakh crore. The interest paid on oil bonds amounts to 4.4% of this amount.

In 2021-22, the current financial year, Rs 10,000 crore worth of oil bonds are maturing and hence, need to be repaid. The interest that needs to be paid on the oil bonds during the year should amount to around Rs 9,500 crore. So, during 2020-21, around Rs 19,500 crore will be needed by the government to service these bonds.

In an answer provided to the Lok Sabha recently, the government had said that the total excise duty earned on petrol and diesel, between April and June this year, had stood at Rs 94,181 crore.

Given that, the second Covid wave was on during this period, and that it would have negatively impacted the consumption of petrol and diesel to some extent, it is safe to say that if excise duty on petrol and diesel continue to be where they are, the total collections this year can easily touch Rs 4 lakh crore. Of course, the collections on petroleum products will be even greater.

Rs 19,500 crore works to around 4.9% of Rs 4 lakh crore. So, the government is likely to spend one-twentieth of the excise duty earned on petrol and diesel, in servicing the oil bonds (both repaying maturing bonds and paying interest on the outstanding bonds).

The remaining bonds worth Rs 1,20,923 crore (Rs 1,30,923 crore minus Rs 10,000 crore worth of bonds maturing this year), will mature between November 2023 and March 2026.

The other argument that is being made is that the government needs to save money in order to repay these bonds in the years to come. It is worth clarifying here that the government meets the expenditure of a given year from the revenue earned during that year. Hence, bonds maturing in 2023, 2024, 2025 and 2026, will be repaid using taxes earned during that year. This nullifies the argument about the government having to save in order to repay these bonds.

Hence, the entire argument that the oil bonds have led to a situation where the government has had to charge a high excise duty on petrol and diesel, is totally wrong. In fact, as I have explained earlier, the reason for this lies in the fall of corporate tax collections.

In 2018-19, the total corporate tax or the income tax paid by corporates had stood at Rs 6.64 lakh crore. This fell to Rs 5.57 lakh crore in 2019-20. It fell further to Rs 4.57 lakh crore in 2020-21.

This fall was on account of the base rate of corporate tax being cut from 30% to 22% in September 2019. It can also be argued that Covid must have led to lower profits for corporates in 2020-21 and hence, lower corporate tax collections for the government.

Data from the Centre for Monitoring Indian Economy tells us that in 2020-21, the net profit of listed corporates (more than 5,000 companies) increased by 120.3% in comparison to 2019-20. So, Covid didn’t impact profits among the listed corporates. While net profit went up by 120.3%, the corporate tax paid by these companies went up just 13.9%.

Covid has negatively impacted smaller businesses and that must have impacted corporate tax collections to a certain extent. But a bulk of the fall in corporate tax collections seems to have come from a lower rate of tax. This has been compensated through higher excise duty on petrol and diesel.

In 2018-19, excise duty earned on petroleum products by the central government brought in Rs 2.14 lakh crore. This jumped to Rs 3.72 lakh crore in 2020-21, thanks to a higher excise duty on petrol and diesel.

The corporate tax cut was supposed to boost consumption and lead to an increase in corporate investment. But that hasn’t really happened. Expecting consumption to increase thanks to lower corporate taxes was kite-flying at its very best.

Consumption increases when people see the prospect of earning more money, not when corporate taxes go down. Investment, for a whole host of reasons, has been down in the dumps for close to a decade now,. I shall not go into these reasons in detail here, having dealt with this issue on multiple occasions in the past.

This has created a communication problem around high petrol and diesel prices for a government obsessed with managing the narrative.

In their book Nudge—The Final Edition, Richard Thaler and Cass Sunstein talk about the publicity principle, originally elucidated by the philosopher John Rawls. As Thaler and Sunstein write: “If a firm or government adopts a policy that it could not easily defend publicly, it stands to face considerable embarrassment, and perhaps much worse, if the policy and its grounds are disclosed [emphasis added].”

This is precisely the problem with the entire messaging around the issue of high petrol and diesel prices. The only reason for this is the high excise duty on petrol and diesel, in order to compensate for lower corporate tax collections.

The excise duty on petrol has gone up from Rs 9.48 per litre in October 2014 to Rs 32.90 per litre currently, a jump of close to 250%. A bulk of this increase of around Rs 10 per litre has happened in the last one year. A similar story has played out with diesel, with excise duty going up from Rs 3.56 per litre in October 2014 to Rs 31.80 per litre currently, a jump of close to 800%. (I would like to thank Chintan Patel for providing this information by using the central government notifications on excise duty on petrol and diesel).

Of course, this is not something that a narrative obsessed government can admit to. This would mean telling the world at large that the common man is being made to pay for lower corporate taxes. This has led to the entire narrative around oil bonds and they having to be repaid and interest having to be paid on them, and that leading to a higher excise duty on petrol and diesel, and hence, higher pump prices of fuel.

This is a narrative that can be easily sold on WhatsApp, given that most people don’t have the time to check the facts of any argument and buy anything that is sent to them over the world’s newest and the most happening university.

As Thomas Sowell writes in Knowledge and Decisions:

“To exhort the individual citizen to make investments in knowledge comparable to those of lobbyists and political crusaders (both of whom have much lower costs per unit of personal benefit) is to urge him to behaviour that is irrational, if not physically impossible in a twenty-four hour day.”

This is something that the current government is making use of and projecting a narrative that wrongly blames the past government for high fuel prices.

As Thaler and Sunstein write: “Organizations of all forms should respect people, and if they adopt policies that they could not and would not defend in public, they fail to show that respect. Instead, they treat citizens as tools for their own use or manipulation [emphasis added].”

This is precisely what is happening.

The interesting thing is that the government has given the more or less the right reason behind high fuel prices in an answer to a question raised in the Lok Sabha. As it said: “The excise duty rates on petroleum products are calibrated from time to time with the objective of generating resources for infrastructure and other developmental items of expenditure, taking into account all relevant factors and keeping in view the prevailing fiscal situation.”

Every government has the right to tax the citizens in different ways. This answer tells us precisely that. Of course, explaining the rationale behind the tax is not always that straightforward.

Vivek Kaul : Of Government taxes, Bitcoin and the Future of money

Anything can be money if individuals on both sides of the economic transaction are ready to accept it as money. As Yuval Noah Harari writes in Sapiens – A Brief History of Humankind: “Money is anything that people are willing to use in order to represent systematically the value of other things for the purpose of exchanging goods and services.” Of course, for something to emerge as a form of money at a societal level, it needs to be widely accepted.

This is the hope that the believers in bitcoin and other cryptocurrencies have been peddling for a while to make them look like attractive investments. That one day when enough number of people across the world are tired with the government backed fiat money or paper money as it more popularly known, cryptos will take over.

Of course, you can’t wait for that to happen, and you need to buy bitcoin now. This is one of the ways in which the fear of missing out or FOMO, is created.

So how logical is this argument? How much should we trust it? These are questions well worth asking.If you look at the history of money, different things have been money at different points of time. In the prisoner-of-war camps of the Second World War, cigarettes emerged as a form of money. They are a great example of the fact that anything can be money if both the sides of the economic transaction are willing to accept so. Also, any system where conventional money is not around, like in a prison, does not continue to stay in a vacuum, and newer forms of money emerge.

Different agriculture commodities including tobacco have been money at different points of time. So have been different metals, everything from iron and bronze to silver and gold.

Hence, different things have been money at different points of time, during the course of human history. What this tells us is that as long as enough people accept something as a form of money, it can continue functioning as money, until it doesn’t.

This means that bitcoin and cryptocurrencies can also become a form of money, over a period of time. Nevertheless, if we leave it at just this, it will be lazy reasoning at best. Also, this is where things get a tad complicated.

Allow me to explain.

Pure paper money or fiat money or money not backed by any commodity (gold, silver, tobacco, iron, copper etc.) has been around for many centuries, nevertheless, it has flourished and been widely accepted only in the last hundred years.

Why is that the case? Why do people happily and readily accept money not backed by any commodity as a form of payment, on most days?

As L Randall Wray writes in Modern Money Theory:

“The typical answer provided in textbooks is that you will accept your national currency because you know others will accept it. In other words, it is accepted because it is accepted. The typical explanation thus relies on an “infinite regress”: John accepts it because he thinks Mary will accept it, and she accepts it because she thinks Walmart will probably take it.”

To put it a tad simplistically, paper money is accepted because paper money is accepted. Are we saying there is a mass delusion at work? Is fiat money fiction?

As Jacob Goldstein writes in Money – The True Story of a Made-Up Thing:

“Money is a made-up thing, a shared fiction. Money is fundamentally, unalterably unalterably social. The social part of money—the “shared” in “shared fiction”—is exactly what makes it money. Otherwise, it’s just a chunk of metal, or a piece of paper, or, in the case of most money today, just a number stored on a bank’s computers.”

Now that maybe true, but that’s not important. What is important is to understand what keeps this shared fiction, this mass delusion, this myth, or whatever else you might want to call it, going. And this is where the government, which issues fiat money and controls the fiat money system, comes in.

For the government, it is important that its citizens continue to believe in the shared fiction of fiat money and continue accepting it as a form of payment. What keeps it going? Before answering this question, it is important to understand that there are three things that make a government a government: a) The right to tax. b) The right to legal violence. c) The right to create money out of thin air.

Two out of three rights are important to the context of bitcoin and cryptocurrencies. The right to tax and the right to create money out of thin air. In the past, I have talked extensively about the fact that any government letting bitcoin and cryptocurrencies operate smoothly is essentially giving away its right to create money out of thin air. And they aren’t exactly waiting to do it. (You can read about this here, here and here).

So, what about the right to tax that any government has?

As Wray writes:

“One of the most important powers claimed by sovereign government is the authority to levy and collect taxes (and other payments made to government, including fees and fines). Tax obligations are levied in the national money of account: Dollars in the United States, Canada, and Australia; Yen in Japan; Yuan in China; and Pesos in Mexico. Further, the sovereign government also determines what can be delivered to satisfy the tax obligation. In most developed nations, it is the government’s own currency that is accepted in payment of taxes.”

And not just in developed nations, even in lesser developed ones, the governments accept tax payments in the fiat money of the country. This is what keeps the fiat money system going. As Wray writes: “It is because anyone with tax obligations can use currency to eliminate these liabilities that government currency is in demand, and thus can be used in purchases or in payment of private obligations. The government cannot easily force others to use its currency in private payments, or to hoard it in piggybanks, but government can force use of currency to meet the tax obligations that it imposes.”

In simple terms, government taxes can only be paid in fiat money and that creates demand for fiat money or paper money not backed by anything, and keeps the system going.

A counter argument to this might be that while this might be true in countries where taxes form a significant part of the economy, but how does it work in countries where taxes are not a significant part of the economy. Why does the paper money system still hold?

The answer lies in the overall structure. Companies which operate in a country need to pay taxes to the government in fiat money. So, they carry out their business in fiat money; accept and make payments in it. This means their employees, suppliers (their employees), contractors (their employees), distributors (their employees) and so on, everyone gets paid in or must pay in paper money as well.

When people who are a part of the overall business system, which needs to pay different kinds of taxes, get paid in paper money, they go out and spend that paper money. Hence, individuals and institutions who sell to these people, must then accept paper money. So, the cycle keeps going. And there is demand for paper money or fiat money.

Also, it is worth mentioning here that taxes form a significant part of the economy in any developed country in the world. For any monetary revolution to happen, the governments in these countries need to buy the idea of bitcoin and other cryptos, and also actively promote them. El Salvador classifying bitcoin in a legal tender isn’t going to help that cause. Or the fact that Nigerians have taken on to bitcoin like no one else. These are exceptions to the rule.

The larger point here is that the structure of fiat money being needed to pay government taxes, keeps the paper money system going and will continue to keep it going in the time to come. The demand for fiat money will remain. As long as that is the case, bitcoin and other cryptos will be a sideshow at best, keeping the believers interested, at least for a while.

Also, governments are not going to give up on their right to create money out of thin air. This explains why money central banks are now in the process of planning and/or launching their respective central bank digital currencies.

Of course, people who do not like to pay their fair share of taxes also do not like the idea of being a part of the formal financial system (which is what fiat money system on its whole is at the end of the day). Therefore, people who are a part of the black economy like to convert their profits on which they haven’t paid cash, into other assets like real estate (held benami), gold (easy to store), precious stones (easy to move around) etc. It also explains why people operating in the black illegal economy love bitcoin and other new forms of crypto.

On the flip side, those who run the fiat money system have been abusing it post 2008, when the financial crisis broke out, and post late 2019, when the world was hit by the Covid pandemic.

A lot of fiat money has been created out of thin air, to get economic activity and economic growth going again. This is offered as a major reason by crypto believers, as to why the world should be shunning paper money and buying bitcoin and other cryptos. There is a lot of paper money being created out of thin air, but only 21 million bitcoin are only ever going to be mined.

Hence, the cryptosystem is built around the concept of scarcity whereas with more and more paper money being created, high inflation can become the order of the day and wealth stored in fiat money can lose value at a very fast pace.

The trouble with this argument is that while more bitcoin cannot be created, anyone and everyone, who understands these things, can create a new cryptocurrency. Which is why there are thousands of cryptos going around. As renowned investor Ray Dalio put it in a note on bitcoin: “Competition will, play a role in determining bitcoin and other cryptocurrency prices. In fact, I assume that better ones will come along and displace this one because that is the way the evolution of everything works.” Given this, in the years to come, gold will still be around, about bitcoin, we really don’t know.

So, the point is you don’t know which crypto is going to be around in the days to come. And given that, how do can you ensure that the value of your wealth remains the same, by investing in crypto. Plus, at the risk of sounding cliched, the price volatility of cryptos continues to remain a huge risk.

Something which falls by 50% in a matter of months, cannot even aim to be an asset class, forget being a form of money. The crypto believers now offer the example of stablecoins, which are basically cryptos pegged to paper or fiat money. They have price stability. But their stability comes from being linked to fiat money in the first place.

As Mark Carney writes in Value(s) — Building a Better World For All: “The highest-profile examples of stablecoins… are best thought of as payments systems rather than money per se since they derive their moneyness from the underlying sovereign currencies.”

To conclude, a small story. Before the crypto crash happened, a gentleman on Twitter very confidently told me that he would rather buy dogecoin, which was launched as a joke on bitcoin, than the US dollar. This is because the dogecoin wasn’t being created out of thin air (which is not true, given that the amount of dogecoin goes up every year, but we will ignore that here) and the dollar was.

His point was that the US dollar was not backed by anything. The US dollar is not backed by anything in the physical sense of the term, but it is backed by the US sovereign, the biggest economy in the world, perhaps the most innovative economy in the world and the biggest empire the world has ever seen. Also, the dollar has an exorbitant privilege. While other countries need to earn it, the US can simply print it. Which explains why the demand of for the dollar continues to remain solid, despite its abuse.

Yes, to that extent, it is not backed by anything and bitcoin and other cryptos are backed by everything.

What I can’t get my head around is that if you can’t trust the government (and there are reasons not to), how can you trust a few random guys launching their own crypto in their own backyard. Something which can be moved up and down by a few tweets. How is this fiction better than the government’s fiction? I really don’t have an answer for that.