Fitch: India to rely on next fiscal year's budget for oil subsidies

(The following statement was released by the rating agency)

SINGAPORE/MUMBAI (Fitch) Fitch Ratings says that the Indian government will have to rely on its budget for the financial year ending March 2015 (FY15) to fund a part of the current financial year's oil subsidies bill.

The government allocated 650 billion rupees for petroleum subsidies in FY14, of which 450 billion rupees was used to pay oil marketing companies for the subsidy gap incurred in the previous financial year. This leaves the government with 200 billion rupees to meet its share of the shortfall between the subsidised price and the market price, known as under-recovery. This is likely to be insufficient, and it is likely that the state will have to tap around 450 billion rupees from next year's budget.

For the first half of the current financial year, the total under-recovery from diesel, public distribution kerosene and household liquefied petroleum gas (LPG) was 609 billion rupees, with diesel accounting for 283 billion rupees. Assuming the under-recovery in the subsequent two quarters is around 400 billion rupees each, the total FY14 under-recovery would be 1,400 billion rupees (FY13: 1,610 billion rupees).

In January 2013, the government took steps to further deregulate the petroleum sector by allowing diesel for industrial use to be priced at market prices, and also allowed refining and marketing (R&M) companies to increase the prices for retail diesel by INR0.5 a month. This led to a steady decline in the diesel under-recovery. The government also limited the number of subsidized LPG cylinders (on which it incurred an average subsidy of 408 rupees each) to nine per family per year, which will likely reduce the subsidy for the LPG segment in 2H

FY14.

The math of how FY14's subsidy on petroleum products will be shared between the government, the upstream players - ONGC , OIL India and GAIL Ltd (BBB-/Stable) - and the R&M companies - Indian Oil Corporation Limited (BBB-/Stable), Bharat Petroleum Corporation Limited (BBB-/Stable) and Hindustan Petroleum Corporation Limited - is still fluid. With a general election in early 2014, the government's ability to pass on sharp petroleum price increases to consumers on top of the usual small monthly increases would be limited. At the same time, though, the government is under pressure to reduce its budget deficit, to which petroleum subsidies are a large contributor.

In Fitch's view, the upstream players will likely be required to shoulder a greater portion of the total under-recovery. In 1H FY14, ONGC and OIL India were asked to pay 52.5 percent of the total under- recovery of 609 billion rupees, compared with less than 40 percent in previous years.

If the upstream companies bear a larger share of the under-recovery, the cash flow position of the R&M companies would likely improve because the upstream firms are likely to make the subsidy payments faster than the government.

However, if the R&M companies are also required to bear a part of the under-recovery - they bore 8 percent -10 percent of the under-recovery in FY10 and FY11- their profitability, liquidity and credit profiles will be materially impaired. Fitch believes the ability of the state-owned R&M companies to take on the under-recovery has reduced since 2011 because of the weakening of their standalone financial strengths. This may reduce the risk of the government directing the R&M companies to take on a sizeable share of the under-recovery.

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