Need reasonable cap on issue of guarantees by States for better fiscal management: RBI

Subject: Polity

Section: Federalism

Context:

RBI Working Group has recommended that they should be subject to a reasonable cap on issuance of guarantees.

More on news:

Government guarantees should not be allowed for creating direct liability / de facto
liability on the State.
States have been cautioned against using guarantees to obtain finance through State Owned
Entities.
The Working Group on ‘State Government Guarantees,’ consists of members from the
- Ministry of Finance, Government of India;
- Comptroller and Auditor General of India; and
- some State Governments.
The group emphasized that guarantee is a potential future liability that is contingent on the occurrence of an unforeseen future event.
States should continue with their contributions towards building up the Guarantee Redemption Fund to a desirable level of 5 percent of their total outstanding guarantees over a period of five years from the date of constitution of the fund.
As of March end 2021, outstanding guarantees issued by the States stood at ₹7.40lakh crore, or 3.7 per cent of their combined SGDP .

Key recommendations of the working group:

The state governments should consider fixing a ceiling for the incremental guarantees they issue during a year at 5 percent of the revenue receipts or 0.5 per cent of Gross State Domestic Product, whichever is less.
It suggested that the state government assess, monitor and be prudent while issuing guarantees.
State governments may consider charging a minimum guarantee fee for guarantees extended and additional risk premium may be charged based on the risk category and the tenor of the underlying loan.
It also suggested that state governments may publish data relating to guarantees, as per the Indian Government Accounting Standard (IGAS).
A minimum of 0.25 percent per annum may be considered as the base or minimum guarantee fee.
An additional risk premium which is based on risk assessment by the State government, may be charged to each risk category of issuances.
The group said State governments need to classify the projects/ activities as high risk, medium risk and low risk and assign appropriate risk weights before extending guarantee for them, said the group.
Such risk categorisation should also take into consideration the past record of defaults.

About Guarantee Redemption Fund (GRF):

The objective of the GRF is to provide a cushion for servicing contingent liabilities arising from the invocation of guarantees issued by the State governments, in respect of bonds and other borrowings by State Level undertakings or other bodies.
Though the participation from the states in GRF is voluntary.
Around19 States have already established GRF.
The GRF corpus is managed by the RBI.