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MANAGEMENT OF GUARANTEES GIVEN BY THE GOVERNMENT INTRODUCTION: 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 fulfil its obligations. PSUs may also avail cash credit from PSB against the Govt. Guarantee e.g. Hooghly Dock & Port Engineers Ltd., Calcutta. Requirement of Government of India (GOI) guarantee as collateral security to avail cash credit facility is a statutory requirement as per Reserve Bank of India (RBI) guidelines for the companies incurring losses. BASIC ISSUES: Government of India has started its economic reforms with great emphasis on fiscal consolidation. Therefore the issue of fiscal deficit has come to the fore. Public debt has become an integral element of overall program of economic reforms. There has been a shift to market related rates of interest on borrowing by Central Govt. Apart from deficit and debt, the issue that has significant implication for the sustainability of the fiscal position, is that of providing guarantees. With guarantees, element of risk is always associated, hence transparency with regard to its policies and magnitude have raised concerns regarding their proper management. 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, and exclude 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/Depts. 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)ª 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 was 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 was converted into `term loan’ against the Govt. Guarantee. This term loan came into existence on 31/3/1995. The converted amount of term loan was Rs.173.23 crores and it was to be paid over a period of 10 years with a moratorium of 3 years. Obviously it called for extension of Govt. Guarantee for a period of 13 years. Government agreed that HSL would pay guarantee fee @ 1%. This was done in the process of capital restructuring of HSL. HSL did not remit the guarantee fee and requested for overall reduction in it. Initially guarantee was extended for a year subject to payment of guarantee fee @ 1%. However HSL represented subsequently to extend guarantee for 13 years and guarantee fee to be charged should be only 1% for the entire period of guarantee. It has not paid the guarantee fee nor the condition of HSL has improved enabling it to repay the loan. 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:
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 debtorq . 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. However the figures thus collected may not reflect the true picture. There may be cases where the unit is before BIFR and any recovery proceedings are under suspension. NATURE AND PATTERN OF GUARANTEES Total outstanding guarantees of Govt. of India from 1994 to 1998 are presented in the Table-1 below. There is a significant growth in the guaranteesà , which has been graphically depicted in Chart-1 for last 5 years. Total guarantees given by central government in nominal terms has risen from Rs.62, 834 crores to Rs. 73,877 crores. However, in terms of percentage to GDP at current market price, it has gone down from 7.2% to 4.7%' (Chart-1). This drop appears significant but keeping the growth in GDP in mind it may reflect an altogether different picture. TABLE-1
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 (Chart-1) but it indicates higher growth in receipt in comparison to outstanding guarantees (Chart-2). 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
Accounting of Guarantees: Ministry of Finance has issued guidelines Y 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 f . 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: -
ACCOUNTING PROCEDURE
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 requires 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 apparantly 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 emphasise 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. At micro level, the criteria to be followed while giving Central Government Guarantees needs 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
CONCLUSION Till recently, loans and advances guaranteed by the Central and State governments carried zero risk weight. The recent credit policy 1998-99 has introduced 20 per cent risk weight for such advances where guarantee has been invoked and the concerned State Government has been in default as on March 31, 20001 . 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, are 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.
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