States' loan guarantee more than triples since FY17 to Rs 9.4 trn in FY23

The total loan guarantees extended by 17 major states to their entities have more than tripled to Rs 9.4 trillion by FY23 from Rs 3 trillion in FY17, says a report.

While guarantees are contingent liabilities, they may pose a risk to states' fiscal health if a substantial proportion of the stock needs to be serviced by them, warranting robust guarantee monitoring and prudent extension of guarantees in the future so that the financial system as a whole remains resilient.

States often sanction and issue on behalf of their various enterprises, cooperative institutions, and urban local bodies guarantees in favour of their lenders which are generally banks or other financial institutions.

The total loan guarantees extended by the 17 major states to their entities have more than tripled to Rs 9.4 trillion as of FY23 from Rs 3 trillion in FY17. This is equivalent to the entire increase in such guarantees of these states during FY2017-22, Icra Ratings chief economist Aditi Nayar said in the report.

In fact, such guarantees have been steadily increasing over the years, from Rs 3 trillion in FY17 to Rs 7.7 trillion in FY21 and to Rs 9 trillion in FY22.

The states excluded from the report are the Northeastern states and other hilly states along with Goa.

The RBI guidelines include tighter rules for ascertaining guarantee ceiling by a state than is being currently implemented by most states as well as assigning risk weights to guarantees, in addition to enhanced monitoring.

The guidelines also state that guarantees should not be extended for external commercial borrowings, the amount guaranteed should be limited to 80 per cent of the loan, etc.

Moreover, the guarantees should not be used for obtaining finance through state-owned entities, which substitutes budgetary resources of the states.

According to Nayar, this is in line with the change in guidelines on off-budget debt issued by the Centre in FY23 and she feels that together, these two will nudge states to become more selective while extending guarantees to their entities.

Additionally, the working group has also urged the lenders to assess a loan proposal from state-owned entities without taking comfort of a guarantee, which should make the lenders more cautious, going forward as well.

After the 32nd conference of the state finance secretaries in July 2022 favoured some regulatory caps on their guarantees, the Reserve Bank had in the same month set up a working group on state government guarantees, and its report was released on January 16 which suggested that the states charge a minimum fee for guarantees extended by them on loans taken by their enterprises, local bodies, and cooperative institutions.

The report specifically calls for a specific ceiling of 0.5 per cent of GDP for additional guarantees to be issued by the Centre annually as stipulated under the FRBM Act.

"States 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," the report said.

The panel has also suggested that state governments may consider fixing a ceiling for incremental guarantees issued during a year at 5 per cent of revenue receipts or 0.5 per cent of Gross State Domestic Product, whichever is less.

The group also wants the word 'guarantee' to include all instruments, which create an obligation, contingent or otherwise, on part of the state government. Further, the purpose for which government guarantees are issued should be clearly defined.

"There should not be any distinction made between conditional/unconditional, financial/performance guarantees as far as the assessment of fiscal risk is concerned as all of these are in the nature of contingent liability that might get crystallized on a future date. Also states must classify the projects/activities as high risk, medium risk and low risk and assign appropriate risk weights before extending guarantees for them" the panel said.

The RBI had, in the past, flagged the issue of bank finance to government-owned entities, often in violation of the prudential guidelines.

"Since most of these loans are backed by explicit guarantees offered by the state concerned, it may be necessary for the states to take into consideration the risk of guarantee being invoked," the report said.