As a State grows, the need to fund infrastructure projects increases. The Public Sector Enterprises which are executing these projects need funds. While many of them get funds within the State budget, some of the projects require huge investments, for which PSEs turn to banks and financial institutions. The State government stands as guarantor for such loans, otherwise the banks may not be willing to extend loans to such entities.
Given the guarantee, the banks are happy to give loans, often without even doing due diligence about the commercial viability of such projects. Because of the very low risk attached to such loans, they also most often do not monitor the projects they finance. As long as the PSEs are financially sound and servicing the debt, this is a win-win situation. However, if the PSEs turn loss-making, and if the banks invoke the guarantees, it is the State government which will be in trouble. This was the concern that the RBI’s Working Group on State Government Guarantees had expressed in its report released last week.
Chart 1 | The chart shows the outstanding State-wise guarantees issued as a share of each State’s Gross Domestic Products at the end of March in 2018, 2019, 2020, 2021 and 2022.
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For instance, for Andhra Pradesh, the outstanding guarantees as a share of its GDP grew from around 4% to over 10% in the said period. In fact, the guarantees are on an increasing trend in 11 other States — Bihar, Chhattisgarh, Haryana, Karnataka, Kerala, Meghalaya, Rajasthan, Sikkim, Tamil Nadu, Telangana and Uttar Pradesh (Chart 1).
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In Sikkim and Telangana, along with Andhra Pradesh, the share of outstanding government guarantees as a share of their GDPs was above the 10% mark at the end of 2022. Whereas it was around 8-9% in the case of Meghalaya and Uttar Pradesh. The Working Group has asked governments to have a fixed ceiling on the guarantees issued and make it uniform across all States. The Group has also recommended the States assess risks attached to each guarantee and assign weights based on the sector and the borrower’s past record.
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A look at how the States used to finance their Gross Fiscal Deficit shows that two decades back, the National Small Saving Fund (NSSF) was the biggest source of financing (Chart 2). However, due to policy changes, now market borrowings are the major source.
Chart 2 | The chart shows sources used to finance States’ Gross Fiscal Deficit in 2005-06 and 2022-23. Figures in %.
While the share of banks and financial institutions in the financing of States’ gross fiscal deficit has remained low, in terms of absolute numbers they are still considerable as the quantum of loans given by the banks to the States has zoomed over the years (Chart 3).
Chart 3 | The chart shows the loans given by the banks directly to State governments and also to State enterprises that have guarantees from the government.
As can be seen from the chart, both these figures have surged in the recent past.
As the loans are guaranteed by the State, if they are not honoured, the banks may not give fresh loans to the enterprises and guarantees given by the government will fall in value. To avoid that, the Working Group has come up with some recommendations. Having a uniform ceiling for incremental guarantees issued during a year at 5% of the revenue receipts or 0.5% if the GSDP of the State, whichever is less, is the major criterion. The riskiness of the borrowers and projects involved should be considered. A State Finance Department unit should be set up to capture all guarantees and monitor them continually. All States should report in a similar format so that it is easier to oversee.
Source: Report of the Working Group on State Government Guarantees published by the Reserve Bank of India
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