These borrowings were raised by state-owned entities, which also guarantee the loans. Approximately 4-5% of state revenues will go to service these guarantee bonds this fiscal year, which will in part reduce the ability of state governments to fund
The reasons for the rise in off-balance sheet borrowing are twofold. First, limited revenue growth due to the pandemic-induced slowdown and increased revenue spending have caused their budget deficits to rise to almost 4% of GDP, well above the historical level of 2 to 3 % observed for most of the last decade. This has reduced the means available to states to directly fund the entities they own.
Second, even if the states wanted to do this by borrowing more, they cannot without explicit approval and beyond the limits set by the central government. But states do not need prior central consent to guarantee loans and advances and bonds issued by its entities. In addition, coverage limits are self-determined and vary by state. All of these have led to a greater reliance on off-balance sheet borrowing.
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“The electricity sector – mainly discoms – accounts for nearly 40% of outstanding state guarantees. These were levied to reimburse contributions from electricity generation and transmission companies, with discoms continuing to record cash losses. As most of them are expected to continue reporting losses this fiscal year as well, due to rising input costs (mainly coal), States will need to provide greater support for the timely maintenance of guaranteed facilities. . said Anuj Sethi, Senior Director, CRISIL Ratings.
The other beneficiaries of these guarantees are state entities involved in irrigation
But not all public entities will need the support of their government for the management of guaranteed instruments. Around 10-15% of guarantees are also provided to entities involved in urban development and infrastructure provision, which may have their own cash flow to manage guaranteed facilities.
According to Aditya Jhaver, Director of CRISIL Ratings, “We believe that cash flow support will be required for 50-55% of outstanding guarantees, and that 4-5% of the States’ annual revenue will be consumed in servicing these bonds this fiscal year.2 This is more than double the mark seen 4-5 years ago and will therefore partly limit their flexibility to fund capital expenditures in the near future.
With an almost 3x increase in the absolute amount of such secured borrowing over the past five fiscal years, and with state-level entities also approaching capital markets, the fiscal prudence of states in budgeting for these secured bonds and allocating funds to state-level entities in a time-limited manner will be critical.
That said, improving state cash flow through increased collections of goods and services taxes and reducing losses at discoms through cost-reflective tariffs and improved business orientation can provide a little respite in the States. These will remain controllable.