Rs 4.5 lakh crore to Rs 8 lakh crore! Rise in sovereign guarantee comes with hidden risks

The sovereign guarantee route deployed by the government to push credit to coronavirus-impacted sectors and companies will increase outstanding guarantees from Rs 4.5 lakh crore to around Rs 8 lakh crore. The Budget 2021 has listed outstanding guarantee amount at Rs 4.47 lakh crore for the year 2018-19. The finance minister's proposal of a 100 per cent government guarantee to banks for disbursing Rs 3 lakh crore to MSMEs would substantially increase the guarantee amount.

The guarantees carry a big risk of devolving on the government, which could lead to fiscal slippages in future and also invite rating action from global rating agencies. These off balance sheet numbers are analysed very closely by rating agencies, foreign investors and domestic institutional investors who invest in government securities market.

The big shift in the current guarantee exposure is the credit risk that the government is taking on its balance sheet. The loans to MSMEs historically have higher NPAs because of limited scale of operations, lack of management bandwidth, governance practices and family-owned nature of the enterprises. While the private sector banks are quite successful in tapping the right segment, the public sector banks (PSBs), which are the major lenders lack the right business model to appraise the companies, select the right sector, monitor the account and support genuine entrepreneurs.

Currently, the banks' exposure to MSMEs is over Rs 15 lakh crore. Most of the government guarantees comprise of guarantees given to the Reserve Bank of India, banks and financial institutions, Railways and international financial institutions. The rising guarantees are worrying for multiple reasons.

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In a budget size of Rs 30.42 lakh crore, the guarantee amount is one quarter of the budgeted amount. In normal times, the guarantees don't pose a threat, but when there is a scenario of economic slowdown, falling revenues and slippages in fiscal deficit, the guarantee can come back to haunt the government.

As per the FRBM Act, the government has the flexibility of providing guarantee upto 0.5 per cent of the GDP for incremental amount in any financial year. This comes out to be a maximum of Rs 1 lakh crore. It is not known how government has accommodated Rs 3 lakh crore, which is much higher than the incremental limit of Rs 1 lakh crore.

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One reason could be the Rs 3 lakh crore liability is arising only in next financial year 2021-22 because of the one year moratorium on payment of principal payments by the MSMEs.

Over the years, contingent liabilities in the form of guarantees have increased in absolute terms from Rs 1.07 lakh crore in 2004-05 to Rs 4.47 lakh crore in 2018-19. However, the share of liabilities over the GDP have fallen from 3.3 per cent to 2.35 per cent in the same period. But now with budget constraints, the share of guarantees will once again rise.

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