CONTINGENT LIABILITIES

CONTINGENT LIABILITIES

Subject: Economics

Context: The CAG audit report on Kerala finances for 2018-19, tabled in the Assembly on January 18, stated that off-budget borrowings of the KIIFB are unconstitutional.

Concept:

• The government is of the view that as it is providing a guarantee for principal and interest for the loans received by the KIIFB, the borrowings can be termed as contingent liabilities.
• It would become a liability on the government only when there is default by the KIIFB. The CAG has rejected the government view that these are contingent liabilities.

Contingent Liabilities

• Contingent Liabilities of the Government are like insurance obligations, which are contingent or conditional upon the occurrence of certain events, requiring payments by the Government, who had promised or agreed in the past to make good such liabilities, regardless of its financial health.
• It is a possible obligation and not a present obligation. It arises from some past events and its existence will be confirmed only by the occurrence of some future events.
• Its time of payment or the quantum of payment or both are uncertain.
• Contingent liabilities arise mainly because of sovereign guarantees. However, it goes beyond that.

Types of Contingent Liabilities

• A contingent liability may arise due to either explicit legal obligation or an implicit constructive obligation.
• A legal obligation relates to specific government obligation defined by law or contract, e.g., guarantees given against third party, crop insurance, tax refunds under litigation, indemnities, etc.
• A constructive or implicit obligation is an obligation that may arise when a government indicates to other parties that it accepts certain responsibilities and has created certain valid expectation on the part of those parties that it will discharge the responsibilities.
• For example, Letter of comfort issued by governments (Union and States), bailing out public sector insurance, banking and other entities, etc.
• This also represents a moral obligation or expected burden for the government not in the legal sense, but based on public expectations and political pressures.
• On the basis of the provisions made for meeting such contingent liabilities, it can be classified as either funded or unfunded liabilities. eg. the liability is funded in case of sovereign guarantees(Kerala govt stand).
• An unfunded Contingent Liability can arise due to some natural / manmade calamity say Bhopal Tragedy related payments, obligations on account of legislative changes with retrospective effect etc.

Additional Information

• Jahangir Aziz panel and the report of the Financial Sector Legislative Reforms Commission (FSLRC) (2013) studied the issue of public debt management had highlighted the importance of managing contingent liabilities in India.