RBI publishes working Group recommendation on State Government Guarantees

The Reserve Bank of India on Tuesday placed on its website the Report of the Working Group on State Government Guarantees.

A guarantee, in law, is a contract to answer for the payment of some debt, or the performance of some duty, in the event of the failure of another primarily liable person. A government guarantee is an agreement between a financial institution and a government agency. It typically stipulates that if a borrower were to trigger an event of default that could not be resolved, the government agency would make the financial institution whole on its exposure.

The State Governments are often required to sanction and issue guarantees on behalf of various State Public Sector Undertakings/ Local Bodies and other State-owned Companies under the control of various Administrative Departments in favour of various Banks/Financial Institutions to enable the State-owned undertakings etc. to implement different developmental schemes/projects. Though these guarantees do not form a part of the debt burden of the State Govt. as conventionally measured, but in the event of default by the borrowing organisations, the State Government will be required to repay the debt being the guarantor and guarantees become the liability of the State Government.  If these liabilities get crystallised without having an adequate buffer, it may lead to an increase in expenditure, deficit, and debt levels for the State Government. If the guarantee invoked by the bank or financial institution is not honoured, it may cause reputational damages and legal costs to the State Government being the Guarantor.

Under the circumstances, it is important to assess, monitor and be prudent while issuing guarantees, especially, when such guarantees are issued by a State Government. Besides, the State Government should be transparent in terms of data disclosure and assessing the risk associated with it. Another related concern associated with the guarantees extended by the states has been the increasing bank finance to Government owned entities backed by Government guarantees, especially, where the bank finance appeared to substitute budgetary resources of the State Governments.

If the State Government guarantee invoked by the bank/financial institution is not honoured, it may cause reputational damages and legal costs to the Government/Guarantor. Therefore, the 32nd Conference of the State Finance Secretaries held on July 07, 2022 felt that if these liabilities get crystallised without having an adequate buffer, it may lead to an increase in expenditure, deficit, and therefore assessment of debt levels for the State Government and the adequacy of state’s contribution to the Guarantee Redemption Fund, etc., is necessary. Besides, the State Government should be transparent in terms of data disclosure and assessing the risk associated with it. Another related concern associated with the guarantees extended by the states has been the increasing bank finance to Government owned entities backed by Government guarantees, especially, where the bank finance appeared to substitute budgetary resources of the State Governments.  

Given the foregoing, the working group constituted for the above purpose recommended the following.

1. The word ‘Guarantee’ should include all instruments, which create an obligation, contingent or otherwise, on the part of the State Government.
2. The purpose for which Government guarantees are issued should be clearly defined.
3. State Governments may consider fixing a ceiling for incremental guarantees issued during a year at 5 per cent of Revenue Receipts or 0.5 per cent of Gross State Domestic Product, whichever is less.
4. State Governments may consider charging a minimum guarantee fee for guarantees extended and additional risk premiums may be charged based on the risk category and the tenor of the underlying loan.
5. State Governments may publish/ disclose data relating to guarantees, as per the Indian Government Accounting Standard (IGAS).
6. The implementation of the recommendations made by the Working Group is expected to facilitate better fiscal management by the State Governments.

Read: