Fitch Ratings today said the central government needed to act on its fuel pricing and subsidy policy now.

In a new commentary, Indian Fuel Pricing and Subsidy Policy: Time to Act, the rating agency noted that while the reluctance of the government to fully pass on the increases in crude oil prices - and the discretionary nature of the subsidy-sharing - was always a concern in the financial profile of downstream public sector companies, the problem was accentuated in financial year 2009 (FY09) due to the significant increase in crude oil prices during the first half of FY09.

Acxcordding to the commentary, this had led to unprecedented losses (under-recoveries) for these companies during this period. Under-recoveries significantly declined after the huge reduction in crude oil prices of over 70 per cent from the peak in the second half of FY09.

Abhinav Goel, director, Fitch Ratings India, says, "Even if the position appears more comfortable than a year ago - from the long-term perspective of liquidity and financial health of the public sector oil companies, the fiscal position of the government, energy efficiency, and energy security - it is imperative that the government of India takes this opportunity to introduce a transparent mechanism to tackle the issue of fuel-pricing and subsidy to avoid a repeat of a 2008-like situation."

The sheer size and timeliness of oil bond issuance and their monetisation created huge spikes in the borrowings of downstream PSCs, and stressed their liquidity.

However, a reduction in under-recoveries from anticipated levels in the second half of FY09 - as well as the issuance of oil bonds - eased the liquidity position of downstream PSCs.

Goel says in the commentary, "The government has also ensured that downstream public sector oil companies were fully compensated for under-recoveries in FY09, unlike in previous years when they had to bear a part of the subsidy burden. While this is in itself is comforting, concerns still remain on the lack of a well-defined fuel-pricing and subsidy-sharing mechanism.

Even after the reduction in under-recoveries, the government ended up issuing a significant amount of oil bonds from a fiscal deficit perspective, assuming these as on-budget.

Indian Oil Corporation, which has a Fitch rating of  'BBB-'/'AAA (ind)' / Negative, has accounted for Rs40,383 crore (approximately $8.39 billion) of oil bonds in FY09 against less than half the Rs18,997 crore in the previous year.

Similarly for Hindustan Petroleum, the figures more than doubled to Rs14,692 crore, up from Rs7,703 crore, respectively; for Bharat Petroleum Corporation Ltd, and Bharat Petroleum recived oil bonds worth Rs16,216 crore, up from Rs8,589 crore, in 2008.

Upstream public sector suppliers provided discounts of Rs16,902 crore to IOC  in FY09, up from Rs14,322 crore in FY08 ; Rs7,176 crore to HPCL up from Rs5,408 crore, in the arlier; and Rs7,556 crore to  BPCL, up from Rs5,975 crore.

While the actual oil bond issuance for FY09 was lower than envisaged in the first half of FY09, it was much higher than that in FY08. The scenario now is that the crude oil price has increased in the last three to four months, almost doubling from its lowest point in the second half of FY09.

"Though the price might decline again, this does not obviate the need for a clear fuel-pricing policy,"  Goel emphasises.

The retail prices of controlled fuels has not changed during this time, which means that the downstream PSCs are again facing under-recoveries, though their position is much better than a year ago. However, the profitability of the downstream PSCs might be affected if gross refining margins remain subdued.

Another difference from the previous year is that the parliamentary elections were due at that time; while now the re elcted government is firmly in place, with a more comfortable majority. Given the local political and global oil market scenario, it appears to be an opportune time for a critical policy decision like this.