Limited guarantees

Elections '99

The Indian Express

The Financial Express

Limited guarantees

Financial institutions are reportedly asking state governments to make budgetary provisions for guarantees given to state projects. The demand is an indication of the size of the problem. Cash-strapped states have found the easy way out by replacing fund-based assistance to projects by guarantees. The Reserve Bank of India has drawn attention to this trend, pointing out that the demand for extending guarantees has been rising because of shrinking capital expenditure of states and their limited borrowing capability, on the one hand, and the pressures of trying to achieve higher growth on the other. The recent Technical Committee on State Government Guarantees has recommended the setting up of a limit on guarantees, ensuring greater selectivity in calling for and providing guarantees, and constituting a Contingency Fund. The panel pointed out that outstanding state guarantees had risen almost 100 per cent since 1992, with an annual compound rate of growth of 13.1 per cent since March 1995. Clearly, thesituation is fraught with serious implications for the financial sector.

But it is debatable whether the solution lies in making a budgetary provision. All that the states would do is borrow more in order to make the budgetary provisions, and it is the FIs and banks which will fund those borrowings. Rather than depend upon the state guarantees, therefore, FIs will be well advised to judge the viability of projects on a standalone basis. Now that FIs have to make provisions even if defaults have the backing of state guarantees, these have to be evaluated just like any other credit enhancement mechanism. Till state government finances show signs of improvement, FIs would do well not to sanction loans to projects based on the highly dubious comfort provided by state guarantees.

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