RBI panel suggest cap on state guarantee’s at 5 % of revenue

Mumbai: The Reserve Bank of India’s (RBI) panel on State government guarantees has suggested that state governments should consider fixing a ceiling for the incremental guarantees they issue during a year at 5 per cent of the revenue receipts or 0.5 per cent of Gross State Domestic Product, whichever is less.

“Guarantees while being innocuous in good times, may lead to significant fiscal risks and may burden the state finances leading to large unanticipated cash outflows and increased debt. As upfront cash payment is usually not required in case of guarantees, that may be one of the reasons why the State Government guarantees have profligated in recent times,” noted the RBI working group in its report.

It suggested that the state government to assess, monitor and be prudent while issuing guarantees. The panel also recommended that state governments may consider charging a minimum guarantee fee for guarantees extended and additional risk premium may be charged based on the risk category and the tenor of the underlying loan. It also suggested that state governments may publish data relating to guarantees, as per the Indian Government Accounting Standard (IGAS).

The word ‘Guarantee’ should be used in a broader sense and may include instruments, by whatever name they were called, if these create obligation on the part of the Guarantor (State Government) for making payment on behalf of the borrower (State Enterprise) at a future date, contingent or otherwise.

The panel said that the state governments have been issuing guarantees on behalf of state public enterprises belonging to various sectors viz. power, co-operative, agriculture, transport, water supply, sanitation, housing, communication, industries, etc. The probability of default could vary across sectors, depending on the financial parameters of the sector and varying impact of macroeconomic shock.

Therefore, reporting only the nominal value of guarantees may not present the true picture of the risk that the State Government would be exposed to. The panel suggested that states should continue to build up the Guarantee Redemption Fund (established to cushion liabilities due to invocation of guarantees) to a desirable level of five per cent of their total outstanding guarantees.Though the participation from the states in GRF is voluntary, 19 states have already established GRF.

The GRF corpus managed by RBI stood at Rs. 10,839 crore as on March 31, 2023. The panel was against government guarantees being used to obtain finance through State owned entities.

The other recommendations were that guarantees should be given only for principal amount and normal interest component of the underlying loan. They should not be extended for external commercial borrowings; state government may not extend guarantee for more than 80 per cent of the project loan, depending on the conditions imposed by the lender.

Government guarantees should not be provided to private sector companies/ institutions; and appropriate pre-conditions may be specified by the government while giving the guarantees, e.g., period of guarantee, levy of fee to cover risk, representation for government on the Board of Management of the borrowing entity, mortgage or lien on its assets, submission of periodic reports and accounts to Government, right to get its accounts audited, etc said the RBI report.