GS Paper III

News Excerpt:

A working group constituted by the Reserve Bank of India (RBI) made certain recommendations to address issues relating to guarantees extended by State governments. 

About the Guidelines of RBI on State guarantees:

• Uniform reporting framework and definition: The RBI suggests a uniform reporting framework and a broadened definition of guarantees. Guarantees, legal obligations for states, may pose fiscal risks during economic downturns. The term 'guarantee' should encompass all instruments creating state obligations for future payments.
• Restrictions on financing through state-owned entities: The Working Group has recommended that government guarantees should not be used to obtain finance through State-owned entities, which substitute budgetary resources of the State Government. Additionally, they should not be allowed to create direct liability/de-facto liability on the State.
• Limitations on guarantee extension: The guarantee must not be extended for external commercial borrowings, must not be extended for more than 80% of the project loan and must not be provided to private sector companies/ institutions. Adherence to Government of India guidelines is recommended, limiting guarantees for specific loan components.
• Risk weight assignment and ceiling on issuance: States should assign risk weights (high, medium, low) considering past default records before extending guarantees. A ceiling on guarantee issuance is proposed to avoid fiscal stress, limited to 5% of Revenue Receipts or 0.5% of Gross State Domestic Product (GSDP).
• Enhanced disclosure requirements: The working group calls for improved disclosure by banks/NBFCs on credit backed by state government guarantees.

Reasons for loan guarantees given by state governments

• Infrastructure development support: The State governments provide loan guarantees to support infrastructure projects undertaken by Public Sector Enterprises (PSEs) that require substantial investments.
• As states grow, the need for funding such projects increases.
• Risk mitigation for lenders: Banks and financial institutions may hesitate to extend loans without guarantees.
• Government guarantees reduce the risk for lenders, making them more willing to provide funds.
• Economic development facilitation: This facilitates PSEs in obtaining financing for critical projects, contributing to economic development.

However, the guarantees pose challenges if PSEs face financial difficulties, potentially burdening the state government if invoked.

Issues associated with state loan guarantees:

• Due to the perceived low risk associated with guaranteed loans, banks often do not actively monitor the projects they finance. Inadequate monitoring becomes a concern if Public Sector Enterprises (PSEs) face financial difficulties.
• The financing landscape for Gross Fiscal Deficit has shifted over two decades, moving from the National Small Saving Fund (NSSF) to market borrowings as the major source.
• While the share of banks and financial institutions in financing states' gross fiscal deficit remains low in percentage terms, the absolute quantum of loans has significantly increased over the years.

• The increasing trend of state government guarantees poses potential risks, as seen in Andhra Pradesh, where outstanding guarantees as a share of its GDP surged from around 4% to over 10%.
• 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.
• 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.

Conclusion:

In addressing the challenges of rising government guarantees, the RBI's Working Group presents constructive recommendations. The recommendations by the RBI working group aim to enhance fiscal responsibility and transparency. It seeks to protect states from financial burdens by ensuring proper guidelines and limits, promoting a more secure and responsible financial environment for state governments.

Prelims PYQ

Q. Consider the following statements: (UPSC 2018)

1. The Fiscal Responsibility and Budget Management (FRBM) Review Committee Report has recommended a debt to GDP ratio of 60% for the general (combined) government by 2023, comprising 40% for the Central Government and 20% for the State Governments.
2. The Central Government has domestic liabilities of 21% of GDP as compared to that of 49% of GDP of the State Governments.
3. As per the Constitution of India, it is mandatory for a State to take the Central Government’s consent for raising any loan if the former owes any outstanding liabilities to the latter.

Which of the statements given above is/are correct?

(a)   1 only

(b)  2 and 3 only

(c)   1 and 3 only

(d)  1, 2 and 3