The debt in many States has been edging up to alarming levels in recent years. The problem is compounded by the guarantees given by State governments to banks and financial institutions to make them lend to State utilities and other enterprises, which may not figure in the fiscal deficit numbers. Given the weak finances of most of these entities, possibility of these liabilities exploding in the future is quite high.

Latest disclosed numbers show that outstanding State government guarantees have exceeded ₹9-lakh crore towards the end of FY23. The report of the Reserve Bank of India (RBI) working group on State government guarantees is therefore timely. Its proposals are quite sound and need to be implemented soon to check the surge in this hidden leverage. The most important proposal of the working group is to cap the incremental guarantees to 5 per cent of the State’s revenue receipts or 0.5 per cent of its GSDP annually. This is in line with the ceiling of 0.5 per cent of GDP on additional guarantees given by the Central government in a year. This check is necessary because States such as Telangana, Andhra Pradesh, Punjab and Rajasthan had outstanding guarantees which are over 7 per cent of their GSDP towards the end of FY23. Imposing a limit on additional guarantees will help check sudden surges in these contracts based on political exigencies, such as need to spend more ahead of elections. Linking the guarantees to the revenue receipts is a good idea.

The other significant recommendation is the classification of the projects or activities for which State guarantees are given as high, medium and low risk and assigning risk weights to them. This categorisation will enable the State to stay alert to the default risk they face and enable them to make adequate provisions. Asking the borrowing entities to pay a guarantee fee to the State, which will be a minimum of 0.25 per cent per annum will serve the twin purpose of acting as a deterrent as well as providing some revenue for the State. This guarantee fee should be significantly hiked in case the borrowing entity has high risk weight or if it has defaulted on its repayment in the past.

The suggestion of the report that all States should set up a guarantee redemption fund (GRF) which accounts for at least 5 per cent of the outstanding guarantees should be made mandatory. As of now, the creation of GRF is voluntary, because of which it has been set up by only 19 States; Tamil Nadu, Rajasthan, Chhattisgarh, Kerala and Bihar are not even members of the scheme. The outstanding amount in the GRF at ₹10,839 crore towards the end of March 2023 is far from adequate, accounting for only 1.1 per cent of outstanding State guarantees. This fund will be useful if the economic cycle turns adverse. As for banks, the RBI should ensure that its guidelines for vetting loans to these State PSEs are followed. States should also be mindful about the viability of a project while ‘guaranteeing’ it.