The government provides a guarantee on
behalf of an entity when it does not have the requisite creditworthiness/track
record to raise capital or contract a loan on its own and therefore, seeks
protection under the overall umbrella of the government. Article 292 of the
Constitution empowers the Union Government to give guarantees in respect of
loans raised by others within such limits as may be fixed from time to time by
an Act of Parliament. Such guarantees constitute contingent liability of the
Government. Central Government gives guarantee to Public Sector Banks (PSBs)
for some of the transactions of Public Sector Undertakings (PSUs). Guarantees
are given by the Union Government for the repayment of borrowings and payment
of interest thereon, repayment of share capital and payment of minimum
dividend, payment against agreements for supplies of materials and equipment on
credit basis, etc., on behalf of Government companies/corporations, Railways,
Union Territories, State Governments, Local Bodies, Joint Stock Companies,
Co-operative institutions etc. Government of India (GOI) often issue guarantees
to cover part or all of the risk that a borrower will fail to repay a loan or
other guaranteed asset or that an institution will fail to fulfill its
obligations. PSUs may also avail cash credit from PSB against the Govt.
Guarantee e.g. Hooghly Dock & Port Engineers Ltd., Calcutta
BASIC ISSUES:
Government of India
Guarantees given by government carry
liability on the government. The conventional debt statistics reported in the
budget take into account explicit liabilities of the government arising from
its own budgetary transaction. It excludes the implicit liabilities, which
govt. have assumed while providing guarantees to private or public sector.
Conversion of an implicit liability into an explicit one at a later date
depends on the financial status of the beneficiary of the guarantee. However,
it is not included in the conventional debt statistics on the basis of the
presumption that all contingent liabilities are eventually vacated by the
solvent borrower with no implication for govt.’s financial health.
Difference between government’s
contingent and non-contingent liabilities is that nominal obligation and the
settlement date of the latter are fixed at the date of issue, whereas in case
of former (contingent liabilities), the contractual obligation is dependent on
its timing and amount, on the occurrence of an event such as, default by the
principal obligant / borrower. Former is the obligations arising out of a
discrete event that may or may not arise. As mentioned earlier, contingent
liabilities could be explicit or implicit. Law or contracts are two ways
whereby explicit liability is recognised as to implicit obligation of the
government it mainly reflects public expectations. State guarantees issued on
behalf of sub-national governments and public and private sector entities fall
in the category of explicit contingent liabilities. Credit guarantees, trade
and exchange rate guarantees offered by the State, state insurance schemes such
as, for deposits, crops, floods, minimum returns from pension funds etc., are
also in the category of explicit contingent liabilities. Hence, contingent
liabilities are the contractual obligations of the government to provide for
any eventuality of default by the borrower either on principal amount borrowed
or interest payment on such amount or both.
Implicit contingent liabilities would
include, (i) Defaults of sub-national governments and public entities on
non-guaranteed debt and other obligations, (ii) Liability clean-up in entities
being privatised, (iii) Bank failures (support beyond state insurance), (iv)
Failures of non-guaranteed pension funds or other social security funds, (v)
Default of central bank on its obligations (foreign exchange contracts,
currency, defence), (vi) Collapses due to sudden capital outflows and (vii)
Environmental recovery, disaster relief, military financing.
Government is considered to be
sovereign hence its guarantee is absolute. That is the reason why fiscal
authorities are also often compelled to cover the losses and obligations of the
central bank, sub-national governments, state- owned or large private
enterprises, the failure of which would threaten the system. Implicit
contingent liabilities are not recognised until a failure occurs. Markets
expect government support far beyond its legal obligation if financial
stability is at risk as the Asian crisis amply demonstrated. Implicit
contingent liabilities grow with weakness as in the financial sector, macro
economic policies, and regulatory and supervisory system and information
disclosure. In the context of international private capital flows such
weaknesses elevate risks of asset bubbles and over borrowing.
Explicit contingent liabilities are
generally recorded only when the contingency is evident, i.e., when the
guarantee must be redeemed and the necessary budget provision made. The general
ledger system used for accounting can also have a subsidiary system devoted to
registering and tracking the status of guarantees. As the guarantees become due
are redeemed, the necessary action is initiated to make provisions in the
budget.
Guarantee Fee
There are a number of guarantees given
by various Ministries/Departments of the GOI to the PSBs in respect of various
PSUs. Loans and working capital facilities have been provided by PSBs to a
large number of PSUs, and some of these were covered by Govt. guarantees. These
guarantees are generally given for a year and extended every year. In the past,
the Govt. regularly renewed these guarantees. This exercise of extension of
guarantees is carried out by analyzing the merits of the case. Though terms and
conditions of these guarantees are not uniform, government ordinarily charges
fee from PSUs/Inst. to offer these guarantees. Rate of fee varies from type,
quantum and nature of guarantees.
Government charges guarantee fee on a
per annum basis. There is however, no uniformity in the charging of such fees
i.e. there are cases where guarantee fee is not at all charged or charged at
different rates. Guarantee Fee thus charged is deposited in the Consolidated
Fund of India (CFI) with no linkage with the invocation of guarantees.
Guarantees are given by Govt. and its effect in not taken into account. This
year a Guarantee Redemption Fund has been created with a nominal contribution
of Rs. 50/- crores. Keeping the volatility of market in view, assessment of
likely redemption needs to be made more pessimistically. Hence, calling for and
providing guarantees need to be done more selectively. Normally fee itself
should be so structured to reflect the risk and ensure that receipt of fees
would be enough to take care of devolvement under the guarantees.
In a circular issued by the Ministry of
Finance in April 1992, the guarantee fees to be charged on guarantees given by
the Central government were prescribed. Borrowings under the market-borrowing
program were to be charged fee of 0.25 per cent per annum whereas in case of
guarantees covering public sector borrowings the fee was were fixed at 1.00 per
cent and for other sectors it was 2.00 per cent. Problems associated with
timely payment of guarantee fees are common. Instances of lack of proper
management of guarantee fees have also been reported. There are cases where
Institutions are not paying guarantee fee on one pretext or the other.
Outstanding cash credit availed by
Hindustan Shipyard Ltd. (HSL) from State Bank of India
HONOURING OF GUARANTEES
In the past, cash losses of sick and
poor functioning PSUs were funded from the Budget. This practice has since been
discontinued but many of such PSUs are still getting working capital etc. from
the banks on the strength of guarantees. Banks are ready to extend credit/loan
to such PSUs because they have full confidence in Central Government Guarantees.
In general banks assess the risk while giving credit/ loan on the basis of
following parameters:
The company should be commercially
viable with a stable position in the market
The profitability record for the last
three to five years should be good and there should be a prospect of continued
profitability.
The debt equity ratio should be at a
maximum of 2:1 and the current ratio1:3 and
Reasonable inventory levels should
support the credit built up.
If above criteria is followed, most of
the PSUs would not get credit/loan without the cover Central Government
Guarantees. However, this practice of relying heavily on Central Government
Guarantees has resulted in increase in the cases of default of regular payment
by PSUs leading to increase in guarantee invocation.
As per the practice in Banking
industry, the guarantees are invoked when the borrower does not pay the
interest on principal on due date after giving required notices and following
the recall process. In many cases government approached court of law seeking
its help in deferring/disallowing the payment demanded in lieu of the
guarantees. It has been made clear by the courts of Law that amount guaranteed
by Govt. is as good as amount committed to be paid in the event of failure of
the Public Sector Undertaking. The solvency of the principal is not a
sufficient ground for restarting execution of the decree against the surety. It
is a duty of the surety to pay the decretal amount. A guarantee is a collateral
security usually taken by a Banker. The security will become useless if his
rights against the surety can be so easily cut down. (AIR 1969 Supreme Court
The Bank of Bihar Ltd. vs. Dr. Damodar Prasad.) Similarly, as per the decision
given by Supreme Court in SBI V/s Saksaria Sugar Mills Ltd. & other (AIR
1986) under section 128 of the Indian Contract Act, 1872, save as provided in
the contract, the liability of the surety is co-extensive with that of the
Principal debtor . The sureties thus become liable to pay the entire amount.
Their liability is immediate and it is not deferred until the creditor
exhausted his remedies against the principal debtor. Kerala High Court, too,
gave the verdict in the case of V. Velayudhan V/s SBI stating "when a
guarantor gives an undertaking to a person for advancing money to a third
party, the guarantor knows that the other person would not advance money
without such a guarantee. In other words, the money is advanced on the strength
of the confidence reposed in the guarantor of the performance promised or
undertaken. In that view, the position of a guarantor is very near to that of a
trustee.”
Due to the above type of judicial
verdicts govt. is left with no option but to pay the money to the bank,
whenever a guarantee is invoked. That is precisely the reason behind phenomenal
increase in such cases. The information on invoking of guarantees by banks is
being regularly collected by Reserve Bank of India
NATURE
AND PATTERN OF GUARANTEES
Contingent liabilities of the Union
Government is increasing because of its role in promoting investment with
reduced credit risk for investors, especially in those activities where the
nature of investment is characterized by long gestation periods. Total
outstanding guarantees of Govt. of India from 2002 to 2006 are presented in the
Table-1 below. There is a significant growth in the guarantees in last 5 years. Total guarantees given by
central government in nominal terms has risen from Rs.96,859 crores to Rs. 110,626
crores. However, in terms of percentage to GDP, it has gone down from 4.0% to 3.13%.
This drop does not appear significant but keeping the growth in GDP in mind it
may reflect an altogether different picture.
TABLE-1
STATUS
OF GUARANTEES GIVEN BY GOVERNMENT OF
|
||
(Rs. in Crores)
|
||
GUARANTEES
AS ON
|
SUMS
GUARANTEED OUTSTANDING
|
RATIO
TO GDP
|
31ST MAR,2002
|
96,859
|
4
|
31ST MAR,2003
|
90,617
|
4
|
31ST MAR,2004
|
87,780
|
6.7
|
31ST MAR,2005
|
107,957
|
4.27
|
31ST MAR,2006
|
110,626
|
3.13
|
Indian Parliament has set no limit on
the guarantees given by Government. Ideally guarantees should be extended upon
the security of Consolidated Fund of India. These liabilities should always be
analyzed in terms of receipts accruing to the Fund. Outstanding guarantees and
receipts have been tabulated as under (Table-2), guarantee as percentage to
receipts has also been shown in the same table. Outstanding guarantee as
percentage of receipts is declining but it indicates higher growth in receipt
in comparison to outstanding guarantees. This significant amount of guarantees
is a cause of concern. Level of guarantees may not imply immediate obligation
but could imply a large burden on finances in future. Therefore government will
have to be extra vigilant in extending guarantees.
TABLE-2
STATUS
OF GUARANTEES VIS-A –VIS RECEIPTS ACCRUED IN CONSOLIDATED FUND OF
|
|||
(Rs. in crores)
|
|||
GUARANTEES
AS ON
|
SUMS
GUARANTEED OUTSTANDING
|
RECEIPTS
ACCRUED IN CONSOLIDATED FUND OF
|
OUTSTANDING
GUARANTEE AS PERCENTAGE OF RECEIPTS
|
31ST MAR,2002
|
96859
|
265278.8
|
36.51%
|
31ST MAR,2003
|
90617
|
299826.1
|
30.22%
|
31ST MAR,2004
|
87780
|
319100.1
|
27.51%
|
31ST MAR,2005
|
107957
|
376871.1
|
28.65%
|
31ST MAR,2006
|
110626
|
430939.8
|
25.67%
|
Ministry of Finance has issued
guidelines even for the record maintenance and accounting of guarantees. When
guarantees are invoked, the expenditure involved should be treated as loan to
the persons/parties on whose behalf the guarantees were given and recoveries
there against should be watched. Both the expenditure and recoveries, if any, should
be classified in the Government account under a distinct heads. If in due
course, the whole or a part of the loan amount is finally held to be
irrecoverable, the same should be adjusted in the manner indicated below: -
a. Where
a Guarantee Reserve Fund already exists, the amount of loan held to be
irrecoverable should be adjusted by debit to the Fund by following the
accounting procedure prescribed for accountal of expenditure financed from
Reserve Funds.
b. Where
a Guarantee Reserve Fund does not exist, the amount or loan held to be
irrecoverable should be adjusted as ‘Irrecoverable loans written off’ against
the purpose or function it is raised. Where, however, the loan cannot be
identified with any purpose/function, the amount should be adjusted as ‘Miscellaneous
General Services’.
c. Guarantee
Redemption Fund: Government has decided to set up Guarantee Redemption Fund
(GRF) for settlement of claims arising out of invocation of Govt. Guarantees.
Every year provision would be made for building up the corpus of the fund.
Every year, provision thus made, may be used for settlement of claims and net
amount raises balances under GRF. GRF is a non-interest bearing Fund. PSBs
invoke guarantees given to PSUs. Amount thus invoked is paid by the MINISTRY/
DEPT having the administrative control of PSU. For this purpose budget is
provided in the Demand of that Ministry/ Dept. A lump sum provision is made by
Dept. of Economic Affairs. Effect of the transaction on respective Ministry/
Dept. would lead to no deficit. On the basis of the a brief budgeting and
accounting procedure prepared by Director, Budget, following accounting
procedure was suggested by the O/O CCA, Ministry of Finance:
ACCOUNTING PROCEDURE
1. GRF would be created under Major
Head 8235- General and Other Reserve Fund with a new minor head with the
nomenclature ‘Guarantee Redemption Fund’. The amount provided as transfer to
the fund will be accounted for under the minor head ‘Transfer to Guarantee
redemption Fund’, MH-2075 – Miscellaneous General Services, minor head 797.
Receipt to the MH –8235-xxx-GRF would,
effectively be, the amount decided by Government. However, payment from the
same would be resultant of transaction arising out of invocation of guarantees
by PSBs.
Debits to the MH-2075-797- Transfer to
GRF shall be covered by budget provision made in the Grant of Department of
Economic Affairs, Ministry of Finance.
Accounting entry:
Dr 2075- Miscellaneous General Services
- 797 -Transfer to GRF
Cr. 8235-- General and Other Reserve
Fund -xxx -GRF
2. Demand of respective Ministry would
show budget provision against their loan head.
MH xxxx- Loan to ministry / Department
xxx- Transfer form GRF
3. If guarantee were invoked by PSB
against any PSU, payment would be released by the Ministry/ Dept. having
administrative control over the said PSU. Ministry would issue sanction to
their PAO for releasing payment out of the budgeted provision. Thus, PAO would
watch the budget at its disposal.
Accounting entry:
Dr MH xxxx- Loan to Ministry /
Department
xxx- Transfer form GRF
Cr. MH 8670 - Cheques and Bills
4. As transaction should have no effect
on loan head of the Ministry/ Dept. a minus debit is passed to the above loan
head and corresponding debit is passed to the final head i.e. GRF.
Accounting entry:
Dr MH 8235- General and Other Reserve
Fund
xxx -GRF
(-)Dr MH xxxx- Loan to ministry /
Department
xxx- Transfer form GRF
5. Once the guarantee is invoked,
respective PSB gets the payment. This payment is made on behalf of concerned
PSU. It is booked as loan with no net effect on the loan head of the concerned
Ministry/Dept. The case where repayment of such loan takes place has not been
covered in the brief procedure.
6. Guarantees given by GOI are
accounted for and managed by the respective Ministry/Dept. Record of invoked
guarantees should also be available with them. Concerned Ministry/Dept should
monitor payment and repayment of invoked guarantees.
POLICY ON GUARANTEES:
There is no explicit policy on
management of guarantees. In the interest of prudent financial management and
credibility of the guarantees issued, there is a need for a policy on
guarantees. Not only this, the interest of govt. also needs to be protected in
scientific and efficient manner. Therefore, ensuring a responsible policy and
honoring of guarantees once issued is of paramount importance. However, in
order to have a sound system of offering guarantee and honoring them as well as
analysis of cases where extension of guarantee is allowed there must be a
responsible policy.
Process of policy formulation may start
with collection of relevant information and subsequent analysis of the same. To
start with, firstly, it is of great significance to know the quantum of
guarantees issued by the Govt. for various purposes. If possible the impact of
such guarantees on govt. may also require an assessment. Secondly, cases where
govt. has to honor these guarantees are also required to be found out along
with its impact on PSBs/ inst.
Though guarantees do not form part of
debt as conventionally measured, these have in the eventuality of default the
potential of exacerbating an apparently sound fiscal system. Conventional fiscal
adjustment programme aims at reduction of fiscal deficit and debt. It does not
necessarily prevent fiscal instability, as it does not emphasize the hidden
fiscal risk associated with contingent liabilities of the government. Both at
national as well as international fora, it has been recognised that in the
context of fiscal stability and sustainability, the policy makers should
identify, classify and understand the full range of fiscal risk involved in
contingent liabilities. Thus, a meaningful analysis of guarantees issued by
Govt. would also require an assessment of the finances, particularly, the debt
burden and related issues. To carry out this analysis, information is required
in a structured form on guarantees given by Government. In this direction Government
Accounting Standards Advisory Board (GASAB) has come up with standards and
format for disclosures. If information is collected category-wise, purpose-wise
etc., then guarantees’ risk assessment and consequent provisioning in accounts
as well as revision of existing policy on guarantees can be done in a more
scientific manner.
At micro level, the criteria to be
followed while giving Central Government Guarantees need to be decided in
detail. This may cover the entire gamut of guarantees given in respect of
borrowings etc. of public sector and private institutions, as well as the
levels at which the decisions are to be taken. The cases, depending upon their
merit should be handled at different levels. Approval must be granted after
scrutinizing the case in great detail.
Some general guidelines may be handy while deciding on
Guarantees. i
- Any proposal for guarantee by Government must be
justified by public interest.
- The proposal for a guarantee, which amounts to
undertaking contingent liability, should be examined in the same manner as
a proposal for a loan.
- Individual cases should be decided at different levels
depending upon the amount and nature of guarantees.
- In the case of Guarantees in favour of private
institutions, all cases should be got approved by the Ministers concerned
(Minister in-charge of the Ministry as well as the Finance Minister). If
the amount involved exceeds Rs.10 Lakhs in each case (each institution or
group of institutions if the same party is connected with it, the limit
being applied after taking into account the guarantees already given in
respect of the institution or group of institutions) may be considered for
being submitted to the Cabinet for approval.
- Cases involving borrowing from banks and issue of
guarantee to public sector financial institutions or borrowings from
foreign lending agencies should be handled by Ministries in consultation
with Department handling the related technical issues.
- Where public sector undertakings require guarantees to
be given to foreign suppliers they should normally approach banks for
guarantees. Only where the banks are not satisfied about the viability or
the finances of the projects and bank guarantee is not available, a
proposal for counter guarantee by Government is likely to be made. In such
cases it will be preferable for Government to give straight guarantees to
the foreign lending agencies/suppliers provided the agencies/suppliers
find this arrangement acceptable.
- Public Sector Undertakings, now days, undertake works
in foreign countries which involve furnishing of guarantees counter
guarantees for the tenders, mobilization advances retention money,
performance guarantee etc. Such cases should be dealt with the Ministries
concerned.
- Budget Division; Ministry of Finance should be
consulted on all proposal of market borrowing. Insurance Division of the
Ministry of Finance should be consulted on proposals of negotiated loans
from LIC & GIC.
- The Administrative Ministry undertakes a consolidated
review of all the Government guarantees given during a year. Such reviews
help to assess the actual performance of the guarantees and would enable a
decision laid down whether any modification in the criteria already laid
down is necessary or whether the guarantee could be discontinued.
- All cases of guarantees outstanding at the end of a
calendar year are reported to Budget Division, Ministry of Finance by the
concerned Ministry/Department. All payments made in pursuance of the
guarantee are also reported. These should be monitored closely.
- It is important to link the issue of extension to
performance of the PSU. The real issue is whether lending to the public
sector is equivalent to Govt. security or it is to be based on commercial
judgement.
- It has been noticed that number of guarantees and the
amount guaranteed have increased manifold over the years and that once a
guarantee is given it tends to be a perpetual guarantee. In respect of
sick PSUs the guarantees have not been related to any turn-around
packages/measures. Possibility of such linkage must be explored.
Till recently, loans and advances
guaranteed by the Central and State governments carried zero risk weight. Vide
credit policy 1998-99, 20 per cent risk weight was introduced for such advances
where guarantee has been invoked and the concerned State Government has been in
default as on March 31, 2001.
Several states e.g. Karnataka have come up with legislation
to manage and control state guarantees. Similar provision needs to be
introduced for the guarantees given by Central Govt.
Excessive counter guarantees given by
Government to public sector, especially to enterprises which are not viable
e.g. Hindustan Shipyard Ltd., could raise concern due to its potential adverse
implications for the financial sector balance. The hidden subsidy to the
beneficiary of a guarantee, and the subsequent potential cost to the
government, is positively correlated with the coverage (part risk, size, and
duration of the underlying asset. In addition, the probability of default may
be very high if the guarantee contract does not specify risk sharing by both
the government and the other parties in terms of both the financial coverage
(part versus all of the loan) and risk coverage (specific political or
commercial, versus all risks). Government guarantees routinely cover all
risks fully. Such guarantees distort the markets and are called with high
probability. The risk a government assumes can be estimated based on the
experience, absorption capacities, simple rules, and, where appropriate, more
sophisticated methodologies such as actuarial, econometric, loss estimate, and option
pricing models. Assessment of risks allows governments to reflect the potential
fiscal cost associated with guarantees in their choices of policies and forms
of support and in the design of a guarantee contract. In this context it would
be advisable to have a limit on calling for and providing for guarantees.
Explicit policy on the management of
guarantees is highly desired. Though guidelines and circulars have been issued
from time to time there is a need to take a fresh look on the issue of
management of government guarantees. While framing/ re-framing a policy on
guarantees a holistic approach needs to be taken.
Guarantee fee is charged on guarantees
given by Government. Fee collected is credited to a separate head. It does not
have any linkage with the Guarantees redeemed. It would be advisable to levy
appropriate fee on guarantees and credit it to the Guarantee Redemption Fund.
This would enable the fund to grow out of its own resources.
References:- Budget
documents of Government of India.
- Civil
Accounts Manual, Published by Controller General of Accounts, Government
of
- Annual
Reports of RBI.
- Finance
Account 2002, 2003, 2004, 2005 and 2006
- General
Financial Rules of Government of
- Indian
Contract Act,1872
- Report
1 , 2003,2004,2005,2006 and 2007 of Comptroller and Auditor General Of
- Various orders and instructions issued by Ministry of Finance on the issue of Government Guarantees.
Chart-1
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