Report-Mgmt of Guarantees - Madhya Pradesh · Development Corporation. Such resources are raised either by way of loans or through issue of debentures or bonds. By providing its guarantee

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March 2009 1. 2.

Department for International Development, UK

Long Term Consultancy under DFID Assisited Strenghtening Performance Management in

Government Programme Report on Management of

Guarantees

PUBLIC FINANCE

DFID Supported Strengthening Performance Management in Government Programme Long Term Consultant, Government of Madhya Pradesh

Report on Management of Guarantees

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Table of Contents

1. Introduction ................................................................................................................. 3 2. Ceiling of Guarantee ................................................................................................... 4

2.1. Legal Provisions ................................................................................................... 4 2.2. Methodology of Fixing Ceiling on Guarantees .................................................... 5 2.3. Appropriateness of Ceiling on Guarantees ........................................................... 5

3. Guarantee Policy, Procedure and Management .......................................................... 8 3.1. Policy .................................................................................................................... 8

3.1.1. Ceiling on Guarantees ................................................................................... 8 3.1.2. Eligibility for Availing Government Guarantees .......................................... 8 3.1.3. Execution of Agreement ............................................................................... 9 3.1.4. Creation of pari pasu Charge ...................................................................... 10

3.2. Procedure for Obtaining Guarantees .................................................................. 10 3.3. Guarantee Management Framework .................................................................. 13

3.3.1. Centralisation of Issuance of Guarantees .................................................... 13 3.3.2. Computerisation of Guarantee Data ............................................................ 14 3.3.3. Monitoring Repayments.............................................................................. 14

3.4. Revised Guarantee Issuance Procedure .............................................................. 15 4. Guarantee Fee ........................................................................................................... 17 5. Review of Guarantee Portfolio ................................................................................. 20 6. Standardisation of Guarantee Deed Format .............................................................. 22 7. Standardisation of Government Order ...................................................................... 25 8. Guarantee Redemption Fund .................................................................................... 26 9. Summary of Recommendations ................................................................................ 27

9.1. Legislative Amendments .................................................................................... 27 9.2. Policy, Procedure and Management Framework ............................................... 27 9.3. Computerisation of Guarantee Data ................................................................... 28 9.4. Review of Certain Guarantees ............................................................................ 28 9.5. Guarantee Fee ..................................................................................................... 29 9.6. Revision of Guarantee Rules, 1976 .................................................................... 29 9.7. Guarantee Redemption Fund .............................................................................. 29

10. Way Forward ......................................................................................................... 30



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1. Introduction

Governments cannot always provide budgetary support to all the public sector enterprises and other official agencies to meet the latter’s fund requirements because of resource constraints. It often helps them in raising needed resources by providing its guarantee on their behalf to the lending institutions/ investors. These guarantees are however provided when the latter are either not able to raise resources on the strength of their own Balance Sheet or though able to raise resources on their own strength, the cost of raising such funds would be high. Guarantees are also provided, if mandated by law, as in the case of loans given by National Co-operative Development Corporation. Such resources are raised either by way of loans or through issue of debentures or bonds. By providing its guarantee to the lenders, the government takes upon itself an obligation to repay the loan/ bonds/debentures and to pay interest thereon in case of default by the principal borrower. A guarantee thus is an important instrument of economic growth of a state as it helps in mobilizing resources to meet the developmental expenditure. But at the same time it must be clearly recognized that every guarantee creates an explicit contingent liability on the government and is a fiscal risk to the government. This risk has significant fiscal consequences and these can be particularly severe if exposed during periods of financial crisis. While guarantees may be an appropriate form of government intervention, they usually are not subjected to the same degree of scrutiny through the budget process as regular spending. Since all governments in India follow cash system of accounting, guarantees do not get recorded in fiscal accounts when these are issued. These are formally recognized as liabilities and enter fiscal accounts only when these are invoked and payments are made by government to lenders. One undesirable characteristic of government guarantees is the uncertainty that they create for the government. At the time of issuance of a guarantee, the government does not know whether there will be payment obligations related to the guarantee and if so, when and how much. When these contingent liabilities turn into real liabilities due to default by principal debtors, they may pre-empt financial resources from investment projects and may pose a threat to the financial stability of the state. Non- payment of these liabilities when called by lenders can adversely affect the credibility of the government, the borrowing institution and their future borrowing capacity. Government has to therefore exercise caution in issuance of guarantees even when they are within the prescribed ceiling.



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2. Guarantee Ceiling 2.1. Legal Provisions

Article 293(1) of the Constitution of India provides that a state government can give guarantees within such limits as may be fixed by the State Legislature on the security of the Consolidated Fund of the State. Though the State Legislature had not passed any law fixing any limit for issuance of guarantees, the Government of Madhya Pradesh was following a practice of fixing an administrative limit for each year. The administrative limit for issuance of guarantees for the year 2004-05, was fixed at Rs.10,700 crore. The State Legislature passed the “Madhya Pradesh Rajkoshiya Uttardayitva Evam Budget Prabandhan Adhiniyam, 2005”, which provides a basis for fixing a ceiling on government guarantees. Clause 9 (2) (d) of the Act lays down that the State Government shall limit the annual incremental guarantees so as to ensure that the total guarantees do not exceed 80 per cent of the total revenue receipt in the year preceding the current year. The ceiling on government guarantees would thus vary every year depending on the quantum of total revenue receipts in the year previous to the current year. The ceiling would need to be calculated in the beginning of each financial year to ensure that the limit is not breached while issuing guarantees during the year. Since the total revenue receipts of the government keep on rising, the ceiling on government guarantees would also keep on rising every year which can have an adverse impact on the finances of the state. In order to limit the issue of Guarantees, the state government has made another provision in Clause 9 (2) (c) of the above Act, which says that the State Government shall ensure within a period of 10 years, that is as on the 31st day of March 2015, that total liabilities (loans as well as guarantees) do not exceed 40 per cent of the estimated GSDP for that year. The total liabilities, as defined in Clause 2 (j) of the Act, include risk weighted guarantee obligations where the principal and/or interest are to be serviced out of the state budget. The provisions of Clause 9 (2) (d) of the Act relating to the limit on government guarantees and the definition of “total liabilities” as contained in Clause 2 (j) of the Act referred to above are ambiguous and leave scope to different interpretations. These provisions do not provide a clear indication on whether they relate to maximum amount guaranteed or the outstanding amount of guarantees. We have been given to understand that the State Government, at present, considers the maximum amount guaranteed in relation to the above provisions of the Act. In our opinion only the outstanding guaranteed amount should be considered for this purpose as this amount represents the amount of loans availed by entities under various government guarantees net of repayments made, and the liability of the government to the lenders is restricted only to this amount on the date on which the total liabilities of the government are worked out irrespective of the maximum amount guaranteed. The outstanding guaranteed amount should also include outstanding interest, if any, on the guaranteed loans, if the government has guaranteed interest payment on such loans. The Government may consider amendment of the Act to address the ambiguity in these two clauses of the Act. We therefore recommend that the ambiguity in the provisions of Clause 2 (j) and Clause 9 (2) (d) of the Act may be removed and an appropriate amendment in the Act moved to reflect that that they apply to the weighted outstanding guaranteed amounts.



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Further, the valuation of government guarantees is required to be carried out so as to satisfy the provisions of the Act to include only the weighted guarantee obligations of the State in the total liabilities. The Act does not provide the modality of such valuation. In this connection, it may be mentioned that the Reserve Bank of India had set up a Technical Group consisting of Finance Secretaries of select States to assess the fiscal risks of State Government guarantees which submitted its report on July 16, 2002. This Group had studied the methodology for assessing the fiscal risks of guarantee obligations and had suggested that such guarantees could be classified in four categories i.e. Very Low, Low, Medium and High Risk and be assigned devolvement probability of 5 per cent, 25 per cent, 50 per cent and 75 per cent respectively. The Committee had not prescribed any particular method for the categorization of guarantees. The translation of risk assessment to devolvement probability was left to individual States. We recommend that the State Government may engage a credit rating agency for the valuation of all its outstanding guarantees and in the light of the results of such valuation assign the weights as recommended by the Technical Committee referred to earlier and then include the weighted outstanding guarantee obligations in the total liabilities. It would bring down the ratio of total liabilities to GSDP. We have made similar recommendation in our report on Management of Public Debt. We have reiterated it in the present report as it has a bearing on the management of guarantees too.

2.2. Methodology of Fixing Ceiling on Guarantees

As regards the methodology for fixing the ceiling on government guarantees, the Technical Committee on State Government Finances constituted by Reserve Bank of India in 1998-99, which consisted of Finance Secretaries of select States, besides a representative each of the Ministry of Finance, Government of India and the RBI, had observed in its report submitted on February 15, 1999 that there could be four approaches for fixing ceiling on guarantees viz.

a. The first approach is to link guarantees to a dynamic variable such as NSDP. b. The second approach is based on the argument that the NSDP is not a parameter that is

within the ambit of the budgetary management of the State Government and it is more appropriate to link guarantees to the revenue receipts.

c. The third approach is to link the guarantees and debt to the Consolidated Fund itself. d. The fourth approach is to ensure that the ratio of incremental guarantees to incremental

net market borrowings is kept constant or brought down.

The Committee had recommended that State Governments should have sufficient flexibility to choose the most appropriate parameter while ensuring transparency. Different State Governments have chosen different parameters for fixing ceiling on guarantees. The parameter chosen by GoMP linking the ceiling to total revenue receipts, in our view, is very appropriate.

2.3. Appropriateness of Ceiling on Guarantees

While the methodology of fixing the ceiling on guarantees is very appropriate as discussed above, a question arises whether the ceiling so fixed would be appropriate to address the concerns of the state.



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Though GoMP has fixed a separate guarantee ceiling linking it with the total revenue receipts, as also a combined ceiling both for the debt and guarantees linking it with the GSDP, it has not laid down a path for reduction in the growth of guarantees as in the case of debt. In the State FRBM Act, the Government has committed to reduce the revenue deficit to zero and fiscal deficit to not more than 3 per cent by 31st March, 2009. Further, each state government, as a long term goal, is required to bring down the debt-GDP ratio to 28 percent as recommended by the Twelfth Finance Commission. If all these targets are to be achieved, the Government would need to control its future borrowings and the cost of borrowings and other expenditures. A similar path needs to be charted out to check the growth of guarantees. Theoretically speaking, while the debt growth may reduce as a result of concerted actions of the Government, guarantees can go on increasing year after year due to rise in total revenue receipts so long as the guarantees and debt together remain within the overall ceiling of 40 per cent of GSDP. As a part of fiscal reform strategy and to strengthen performance in the government, we may aim at reducing the growth of guarantees and this objective should be clearly pronounced and transparent through a pragmatic and appropriate limit on guarantees. Table 1 shows the trend in growth of ceiling on guarantees with the growth in total revenue receipts from 2005-06, that is the year of enactment of FRBM Act, to 2008-09, that is the year up to which the budget has been presented when worked out on the basis of the provisions of the FRBM Act: Table 1: Ceiling on Government Guarantee vis a vis Total Revenue Receipts (In Rs. crore) 2006-07 2007-08 2008-09 (RE) Total Revenue Receipts 25694 30689 34949 Ceiling at 80 per cent of Total Revenue Receipts 20555 24551 27959 Ceiling at 50 per cent of Total Revenue receipts 12847 15345 17475 Maximum Guaranteed Amount - 10300 - Outstanding Guaranteed Amount - 6890 - Source: Budget Documents The ceiling on guarantees for the year 2007-08 works out to be as high as Rs. 20,555 crore (80 per cent of total revenue receipts in 2006-07) as against the maximum guaranteed amount of Rs 10,300 crore and the outstanding guaranteed amount of only Rs. 6,890 crore. The ceiling on guarantees for 2008-09 goes up to Rs. 24,551 crore and would further go up to Rs. 27,959 crore in 2009-10. At this point of time, it is doubtful whether the Government would really need such high ceilings, given the fact that even the present ceiling remains substantially underutilized. It may, however, be argued that the Government might need a larger ceiling to promote future economic growth. Even if it is so, a ceiling based on 80 per cent of the total revenue receipts seems to be on a higher side. A substantial rise in the ceiling could cause severe strain on State finances at a later date. The fiscal prudence demands that the ceiling on guarantees should be reasonable and sufficient to take care of the state’s developmental needs but at the same time should not be too high to cause turbulence in the State finances any time in future. It is felt that a ceiling based on 50 per cent of the total revenue receipts of the state would meet these twin objectives. The ceiling based on 50 per cent of the total revenue receipts has been worked out in the above table. The suggestion, if implemented, would send out a clear signal to all concerned throughout the state of the government’s intention of checking the growth of guarantees. It would also bring greater discipline in the state level enterprises reducing their dependence on



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government for its guarantees for their fund requirements. This suggestion would require an amendment in the FRBM Act As a measure of economic sector reforms and with a view to strengthening performance management in government, we recommend that Clause 9 (2) (d) of the FRBM Act, 2005 may be amended to limit the outstanding guaranteed amount to 50 per cent of the total revenue receipts in the year preceding the current year.



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3. Guarantee Policy, Procedure and Management

3.1. Policy

3.1.1. Ceiling on Guarantees

Madhya Pradesh State Government Guarantee Rules, 1976, as amended from time to time, govern the issuance and management of government guarantees. These rules, in the present form, do not prescribe any ceiling on guarantees. The Finance Department has been working out the ceiling administratively and relaying it to all the Administrative Departments and the Accountant General. The ceiling on guarantees has now been brought within the legal framework with the enactment of FRBM Act, 2005. The manner in which the ceiling would be calculated has been laid down in the said Act. The provisions of the Act in relation to ceiling on guarantees need to be incorporated suitably in Guarantee Rules, 1976 for reasons of completeness of rules and transparency. The ceiling should be worked out every year in accordance with the provisions of the FRBM Act in the beginning of each financial year and communicated to all the Administrative Departments and the Accountant General to ensure that the ceiling on issuance of guarantees is not breached.

We recommend that Guarantee Rules, 1976 may be amended to incorporate therein the provisions of FRBM Act, 2005 relating to ceiling on guarantees, in order to make the rules comprehensive.

The ceiling should be worked out every year in accordance with the provisions of the FRBM Act, 2005 in the beginning of each financial year and communicated to all the Administrative Departments and the Accountant General to ensure that the officials do not breach the ceiling while issuing guarantees.

3.1.2. Eligibility for Availing Government Guarantees

The rules provide that guarantee will be issued if it serves public interest. There is nothing which the government does which is not in public interest. The scope of the above stipulation becomes too wide implying that guarantee can be issued for any purpose. Government guarantee is an instrument of economic development which has to be used cautiously. It, therefore, can not be issued to every one and for every purpose. The issue of guarantee is required to be restricted to sectors the government intends to promote and these sectors need to be specified in the rules.

Alternatively, the Rules may provide a negative list indicating the institutions to whom or the purposes for which guarantee will not be issued by government. At present, the Rules merely state that the guarantee would normally not be given in favour of a private institution. We suggest that the negative list may be extended to include the following:

a. No guarantee will be provided on behalf of any individual or any private institution. b. No guarantee will be given to any borrower institution which has defaulted in payment of

guaranteed loan instalments or / and interest thereon in the last 5 years.



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c. No guarantee will be issued unless the accounts of the borrower institution have been finalized and audited for the last at least two preceding years.

d. No guarantee will be provided in regard to cash credit accommodation. (Loans against pledge of goods)

e. No guarantee will be provided for raising working capital. f. No guarantee will be given for repayment of share capital and payment of dividend

thereon.

Providing a negative list without indicating the specific sectors would allow the Government to promote investments through issuance of guarantees and the Rules would continue to provide the required flexibility. We therefore recommend that a negative list indicating the purposes for which and the institutions to whom guarantee will not be provided may be finalized and incorporated in the Guarantee Rules for the guidance of Administrative Departments. The negative list, illustratively, may include that guarantees would not be issued for cash credit accommodation, working capital, and for repayment of share capital and payment of dividend, and for and on behalf of individuals and private institutions and those public sector undertakings and official agencies which have either defaulted payments on guaranteed loans during the last five years or which have not finalized the accounts and have not got them audited for the preceding two years.

3.1.3. Execution of Agreement

Under Guarantee Rules, to safeguard the financial interest of the government, the concerned Administrative Department is, inter alia, required to execute an agreement with the principal debtor viz. the borrowing institution which as far as possible should include representation of Government in the management of the borrowing institution, creation of a charge on the immovable properties of the borrowing institution, calling periodical reports from the borrowing institution and power of inspection of accounts of the borrowing institution etc. We have undertaken a sample study of some Administrative Departments to ascertain compliance to the above provisions of Guarantee Rules. Our impression is that the Administrative Departments are not signing any agreement with the borrowing institution. The possibility of Departments not knowing the above requirement is not completely ruled out. By not signing the agreement with the principal debtor, the purpose for which the rule is made gets defeated. In order to make the guarantee process simpler, we recommend that the requirement of signing of agreement with the borrower institution may be done away with. Instead, a composite Guarantee Request Form may be developed by the Finance Department in which the borrower institution should supply all the required information as provided in the Guarantee Rules, 1976 and also an undertaking that in the event of issuance of guarantee by the government, it unconditionally agrees to provide representation of Government in the management of the borrowing institution if and when asked, to create a charge on its immovable properties in favour of the government, if required, to submit periodical reports as may be called by the government and to allow inspection of its books of accounts by officers to be nominated by the Government etc. With these undertakings, the compliance of the Guarantee Rules will be in-built in the system and the interests of the government well protected.



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We therefore recommend that in order to simplify the guarantee process, the requirement of Administrative Department executing agreement with the borrowing institution as stipulated in Rule 5 of Guarantee Rules, 1976 may be done away with. Instead, a composite Guarantee Request Application Form may be developed in which the borrowing institution should provide the information contained in Rule 2 and furnish an undertaking agreeing to do all that is contained in Rule 5 of Guarantee Rules, 1976. This would reduce the work of the Administrative Departments and at the same time protect the financial interest of the Government.

3.1.4. Creation of pari pasu Charge

As stated earlier, the borrower institutions are required to create a charge on their immovable properties in favour of the Government. The rules are silent on the kind of charge that is required to be created. The charge could be a pari pasu first charge or a second charge. A pari pasu first charge is obviously superior to a second charge as in the event of sale of assets all the creditors who have pari pasu first charge will have the first right to participate in the sale proceeds of the assets. The Government interest would be best protected if a pari pasu first charge is created on the immovable properties of the borrower institutions. We suggest that Guarantee Rules may be amended accordingly. We suggest that Guarantee Rules may be amended to provide for creation of pari pasu first charge on the immovable assets of the borrowing institution in order to better protect the interests of the government.

3.2. Procedure for Obtaining Guarantees The procedure to obtain government guarantee, as provided in the Guarantee Rules, 1976 is that the borrowing institution has to apply to the concerned Administrative Department indicating the name of the lending institution, amount proposed to be borrowed, rate of interest, period and schedule of payment, whether the guarantee is needed for the principal amount or both for principal and interest, loans already outstanding, details of default, if any, in repayment of existing loan and the public interest proposed to be served by the loan etc. The application is required to be accompanied by a cash flow statement indicating as to how the existing loans and the proposed loan are to be repaid, and trading accounts, profit and loss accounts and balance sheets for the previous three years.

On the basis of the examination of information/ documents furnished by the borrowing institution or other available record, the Administrative Department has to satisfy itself whether the loan should be guaranteed or not. If the Administrative Department is not satisfied, the application would not be processed further. If the Administrative Department finds the case fit for issuance of guarantee, it would forward the application to the Finance Department for scrutiny and concurrence. The Finance Department would examine the case further to satisfy itself whether the borrowing institution is financially sound and that there is no risk involved in giving guarantee. Based on such satisfaction, the Finance Department may agree to the proposal and would return the case to the concerned Administrative Department which shall obtain the approval of the Cabinet and thereafter issue a government order which will specify inter-alia the terms of the loan



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guaranteed and the rate of guarantee fee. A copy of the order would be forwarded to the Accountant General and the Finance Department. The Administrative Department would then issue government guarantee in favour of the lenders and would enter into an agreement with the borrowing institution. A copy of the agreement is required to be sent to the Accountant General under intimation to the Finance Department. The entire responsibility for issue of guarantees, maintenance of record of such guarantees and ensuring timely repayments rests with the Administrative Departments. In case of default by the borrowing institution, the Administrative Department is expected to repay the due instalments and to recover the amount so paid from the borrowing institution at an interest rate which is 2 per cent higher than the rate at which it had paid interest to the lenders on the defaulted instalments. All cases of default are required to be reported to the Finance Department. The present guarantee issue procedure is shown in Figure 1: Figure 1 : Present Guarantee Issuance Procedure

Borrowing Institution (BI) Administrative Department (AD) Finance Department (FD) Cabinet

Present Guarantee Issuance Procedure

Submit guarantee proposal to AD

Examine proposal and documents submitted by BI

Decision of AD

Receive Rejected proposal

Forward proposal to FD

Receive Rejected proposal from FD

Receive Agreed proposal from FD

Submit Agreed proposal to Cabinet

Receive Rejected proposal from

Cabinet

Receive Approved proposal from

Cabinet

1) Issue Govt. Order2) Signs Guarantee Deed with Lenders3) Signs Loan Agreement with BI

Receive Govt. Order, Guarantee Deed and Loan Agreement from

AD

Examine proposal sent by AD

Decision of FD

Examine proposal sent by AD

Decision of Cabinet

Disagree

Agree

Disagree

Agree

Approve

Reject

Return to BI

Return to BI



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It will be observed that the guarantee proposal submitted by the borrowing institution is subjected to scrutiny at three levels in the government viz. at the level of the concerned Administrative Department, at the level of Finance Department and finally at the level of the Cabinet, before a guarantee is issued. While the proposal can be returned back to the borrowing institution without a guarantee if any one of the three levels of authorities are not satisfied with the merits of the proposal, the issue of guarantee needs the nod of all the three levels of authorities. The final authority to approve the guarantee rests with the Cabinet. In order to examine the effectiveness of the prescribed procedure in actual practice, we undertook a sample study of some Administrative Departments and to understand the scrutiny process of guarantee proposals in practice. We found that the main concern of the officials in the scrutiny process was to judge the soundness of the proposal and the adequacy of the borrowing institution’s cash flows to pay off the debt. The guarantee proposal is put up to the Minister for orders by the Administrative Department with Department’s detailed comments. Similarly, the file is put up by the Finance Department to the Finance Minister before giving its concurrence. Each proposal finally goes to the cabinet for the final decision. The three check-points provided in the rules strengthen the scrutiny process and are intended to avoid any possible default by the borrowing institutions and consequent devolvement of any guarantee on the government. This is a very healthy provision in the Rules although it leads to some administrative processing delays. Despite stringent scrutiny at the time of issuance of guarantees, defaults by the borrowing institutions have taken place from time to time in the past. These defaults are settled by the Administrative Departments either before or after the guarantees are invoked and the payments so made to the lenders are adjusted against the amounts due to the borrowing institutions such as grants or octroi tax compensation. In other cases, the Finance Department makes the payment on account of defaults. There is no provision in the rules to reduce, if not eliminate altogether, the risk of non-payment by the borrowing institution during the currency of the guarantee. The rules do not ensure that the borrowing institution, after the guarantee is issued, follows the financial discipline and service the loan on due dates in accordance with the loan agreement. In order to avoid the risk of non-payment of loan dues by the borrowing institution, we suggest that the rules may be amended to provide for opening of an Escrow Account by the borrowing institution. Each borrowing institution to which the government agrees to provide a guarantee should be asked to open an Escrow account with any nationalized bank/ State owned bank. All receipts, collections and income of the borrowing institution should be required to be deposited in this account. The account could be pledged in favour of the lending institution. The bank would first utilize the balance in the account to pay off the loan liabilities on their due dates to the lenders. Only after meeting such payments, can the surplus amount be withdrawn by the borrowing institution to meet its other obligations. This would bring in financial discipline in the borrowing institutions and at the same time would ensure timely repayment of loan. This would also restrict the demand for government guarantee only to deserving cases. The mechanism of Escrow account is being practiced in some States such as Orissa, with good results. In order to ensure timely repayment of loan instalments and payment of interest on their due dates by the borrowing institution and thereby reduce, if not eliminate altogether, the devolvement of guarantees on the government, we recommend that the Guarantee Rules may be amended so as to provide for opening of an Escrow account by the borrowing institution with a nationalized bank/ state owned bank which would be pledged in favour of the lending institution and in which all the receipts, collections and income of the



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borrowing institution would be credited and the balance in the account would first be utilized to meet payments associated with loan liability. Each guarantee should be allotted a serial number preceded by the year in which it is issued. There are two advantages expected from this system – first, it would be far easier to know instantly the number of guarantees issued in a year and second, detection of any guarantee escaping compilation will be easy. In the event GoMP goes ahead with implementation of CS-DRMS, this task would be automatically done by the software as soon as a guarantee is entered in the system. The serial number of the guarantee should be incorporated on the guarantee agreement for easy identification and cross referencing. We therefore recommend that all guarantees may be allotted a serial number preceded by the year in which they are issued, and the serial number so allotted should be incorporated on the guarantee agreement for easy identification and cross referencing. This is implementable if the guarantee issuance work is centralised as recommended later in the report.

3.3. Guarantee Management Framework

3.3.1. Centralisation of Issuance of Guarantees The Government is managing the guarantee system in the State on a decentralized basis. Although the Finance Department is required to give its concurrence on each guarantee proposal irrespective of the borrowing institution and the Administrative Department under whose jurisdiction it falls, guarantees are issued only by the respective departments. There is no single department in the government which has an up-to-date and full record of all guarantees issued by the government. Copies of all government guarantees executed by various administrative departments are similarly not available at any one place in the government. During the course of our visits to a few select departments, we were given to understand that they are also not maintaining any consolidated record of guarantees issued by them. The Finance Department is required to provide a wide range of information on guarantees issued by all the Administrative Departments for publication in Volume- 5 of Budget Estimates document and in the Statements which are laid before the Vidhan Sabha under the FRBM Act. The Finance Department does not have this information with itself, nor can it compile this information with reference to its own books and files. It has to call for the information from various Administrative Departments every year. It requires significant effort and time on the part of the officials of the Finance Department at different levels. The Administrative Departments too have to spend a lot of time and devote lot of efforts in supplying this information as they too do not have all the details with themselves readily. In this situation, the possibility of some data escaping the compilation and inaccurate data creeping in the compilation cannot be ruled out despite all possible precautions taken by the Finance Department in the compilation of data. We understand from our visits to select departments that mechanism to monitor periodical payments on guaranteed loans is practically non-existent. They come to know of defaults only after the defaults have occurred. They, therefore, cannot take remedial measures in advance. The above problems can be suitably addressed if the work relating to issuance of guarantees is centralised in the Finance Department. This can be done by making a small change in the present guarantee issuance procedure. After obtaining Cabinet’s approval, the concerned Administrative Department may



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issue the government order and execute an agreement with the borrowing institution as provided in the Guarantee Rules and it should send the relative file to the Finance Department for execution of government guarantee in favour of the lenders. Besides issuing guarantee, maintenance of guarantee record, and monitoring of repayment of guaranteed loans and payment of interest thereon on their due dates should also be made the responsibility of the Finance Department. We have recommended in one of our other reports establishment of a Debt Management Cell in the Finance Department. The above work may be entrusted to this Cell. We therefore recommend that the work relating to issuance of guarantees may be centralised and the responsibility of execution of government guarantees, maintenance of guarantee data and guarantee documents, and monitoring of timely payments on guaranteed loans and taking timely remedial measures, wherever called for may be entrusted to the Debt Management Cell in the Finance Department, for better and more effective control on government guarantees.

3.3.2. Computerisation of Guarantee Data

In order to enable the Finance Department to perform its role as suggested above, it would be necessary to computerize the information related to guarantees. In our Report on Review of the Existing Debt and Guarantee Recording and Management System, we have suggested installation of CS-DRMS software in the Finance Department. Once GoMP decides on the option of either going ahead with the implementation of CS-DRMS or activation of the debt module in the existing Treasury system, the entire past guarantee data may be entered in the system. The past data, as a one-time exercise would need to be collected from administrative departments in a manner that fits in to the requirements of the debt management recording software. All guarantees issued after the installation/ operationalisation of the debt management recording software would need to be entered in the system at the time of issue itself to keep the system up-to-date all the time. We therefore recommend that guarantee data may be computerized. The past guarantee data, as a one-time exercise, may be collected from Administrative Departments and loaded on to the debt management system after its installation in the Finance Department. All future guarantees should be entered in the system at the time of their issue itself in order to maintain the system up-to-date. The guarantee liability may be cross checked with the lenders to the extent possible.

3.3.3. Monitoring Repayments

In order to monitor periodical payments on loan liabilities by borrowing institutions, it would be essential for the Finance Department to develop a suitable monitoring mechanism which is simple and easy to operate. In the event the CS-DRMS system is adopted by GoMP and past guarantee data is entered therein, it could provide valuable assistance in developing the monitoring mechanism. The system is capable of producing reports at such periodical intervals as may be desired such as monthly, quarterly etc. showing payments due to the lenders during that period by borrowers on each loan separately. The Finance Department can generate this report say every month and send the report to each borrowing institution after the expiry of the month to



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ascertain the date on which the payment was made and the amount paid on account of principal and interest separately. The report may be sent with a covering letter which too can be standardized and computerized. In order to keep the Administrative Department in the loop a copy of the letter together with the report may be sent to the concerned administrative department. The borrowing institutions should be advised to send their replies to the Finance Department under advice to their concerned administrative departments. On receipt of reply from the borrowing institutions, payment details can be entered by the Finance Department officials in the CS-DRMS. The reply would also show if payments have been missed out. This should put the Finance Department on alert and ascertain the reasons for non-payment. Further course of action by the Finance Department would depend on the reason assigned by the borrowing institution for non-payment. If the subsequent payment is also missed out, it would be a clear indication that the guarantee is heading towards devolvement. The Finance Department would then need to consider the remedial measure to be taken to avoid the devolvement. If the CS-DRMS is thus kept up-to-date, the Finance Department by itself can generate details of outstanding guarantees at the end of the year for publication in Volume-5 of annual budget and for statements that are laid before the Assembly under FRBM Act, without any reference to Administrative Departments. We therefore recommend that Finance Department may develop a computerized mechanism to monitor payments on guaranteed loan liabilities by borrowing institutions with a view to initiating timely remedial measures in case of any likelihood of any guarantee devolving on the government.

3.4. Revised Guarantee Issuance Procedure Based on the suggestions made above, we recommend the following guarantee issuance procedure as illustrated in Figure 2:



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Figure 2: Proposed procedure for issuance of guarantee

B orrow ing Institu tion (B I) Adm in istrative D epartm ent (AD ) F inance D epartm ent (FD ) C ab inet

N ew G uarantee Issuance P rocedure

Subm it guarantee p roposal to AD

Exam ine proposal and docum ents subm itted by B I

D ecis ion of AD

R eceive R ejec ted proposal

Forw ard proposal to FD

R eceive R ejected proposal from FD

R eceive Agreed proposal from FD

Subm it Agreed proposal to C abinet

R eceive R ejected proposal from

C abinet

R eceive Approved proposal from

C abinet

Issue G ovt. O rderR ece ive G ovt. O rder

Exam ine proposal sent by AD

D ecis ion of FD

Exam ine proposal sent by AD

D ecis ion o f C ab ine t

D isagree

Agree

D isagree

Agree

Approve

R eject

R eturn to B I

R eturn to B I

R eceive Approved P roposa l

Forward approved proposa l fo r issue o f G uarantee

Issue G uarantee and Forward to A D

R ece ive G uarantee and Forward to B I

R ece ive G uarantee



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4. Guarantee Fee

Guarantee fee basically serves two purposes viz. it helps the government to meet its commitments on devolvement, and the second it helps in controlling demand for guarantees. Guarantee Rules, 1976 provide that unless exempted specifically, in consultation with the Finance Department, guarantee fee will be charged from the borrower institution at rates and in the manner and the time period that may be prescribed by Government from time to time. Government of Madhya Pradesh had issued a circular addressed to all the Administrative Departments on 31st March, 2005 laying down the rates of guarantee fee and the manner and the period within which the guarantee fee will be payable. The guarantee fee rate is uniform 1 per cent of the guaranteed amount. If the guarantee is provided for a period of less than a year, the fee is payable within a period of 14 days in one instalment from the date of the Government formal order. In cases where the guarantee is provided for a period longer than one year, the fee for the first year up to 31st March is payable in the same manner and within the same time frame as if the guarantee is issued for a year, and for subsequent period the fee is payable on the outstanding amount of guarantee. The responsibility to collect the fee from the borrower institutions and to credit the amount to the government account rests with the Administrative Departments. We recommend that the rate of guarantee fee and the manner and the period within which the guarantee fee is payable may be provided in the Guarantee Rules, 1976. Rules do not provide as to who is authorized to grant exemption from payment of guarantee fee, although such powers in actual practice are being exercised by the highest decision making body viz. the Cabinet. This may be explicitly provided in the rules for the sake of transparency. The Cabinet has exempted cooperative institutions from payment of guarantee fee. The guarantee fee realised by the government during the last 5 years is shown in the following table:

Table 2: Guarantee Fee realised Year Amount

(Rupees Crore)2003-04 1.562004-05 1.152005-06 1.772006-07 2.162007-08 (RE) 1.09Source: Finance Accounts/ Budget Documents The outstanding amount of guarantees, as reflected in Volume 5 of Budget Estimates document, was of the order of Rs. 5,579 crore as on 31st December, 2007. After deducting outstanding guarantees of Rs. 1,496 crore issued on behalf of cooperative institutions which have been specifically exempted from payment of guarantee fee, the effective outstanding guarantee amount from the point of payment of guarantee fee comes to Rs. 4,083 crore as on the above date. The guarantee fee that should accrue to the government on this amount at the prescribed rate of 1 per cent comes to Rs. 40.83 crore. As against this receivable, the actual receipt has



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been of the order of only Rs. 1.09 crore as may be seen from the Table 2. Furthermore, the difference between the receivable amount and the amount actually received viz. Rs. 39.72 crore should represent the amount outstanding due for recovery for one year alone, which is however not the case. The outstanding amount of guarantee fee as on 31st December, 2007 stood at a meagre Rs. 3.58 crore in Volume 5 of the Budget Estimates document. Only three departments viz. Commerce, Industry & Employment Department, Urban Administration & Development Department, and Backward Classes & Minorities Welfare Department, have reported the above outstanding; the rest have reported zero outstanding. It is very clear from the above analysis that there has been a loss of revenue to the government on account of guarantee fee. The recovery of this amount that is lawfully due to the Government becomes an issue which needs to be addressed. Realisation of guarantee fee in the year in which the guarantee is issued is easy as issue of guarantee is dependent on payment of guarantee fee within 14 days of the issue of the Government order after the Cabinet approval. If the fee is not paid, the guarantee may not be issued. Recovery of guarantee fee in subsequent years poses a challenge. Although the government circular letter dated March 31, 2005 referred to earlier put the onus of recovery of guarantee fee on the Administrative Departments, the departments do not have any effective mechanism to do so. Some of the departments may not even be aware that guarantee fee is required to be collected from the borrower institutions every year on the outstanding guaranteed amount till such time the guaranteed amount is fully paid off. It has to be recognized that it is not easy to recover the guarantee fee for the years subsequent to the year of issue of guarantee without a strong follow-up by Administrative Departments with the borrower institutions. The Administrative Departments are constrained in undertaking follow up work owing to either lack resources or motivation to do the required follow-up. All the borrower institutions may not pay the guarantee fee on their own volition. A mechanism which ensures automatic recovery of guarantee fee is, therefore, what is required. As already recommended in this report, an Escrow account mechanism (if adopted) may be used for recovery of guarantee fee also. At the time of opening the account it would need to be stipulated that payment of guarantee fee out of the account would get the same priority as repayment of loan instalments and payment of interest. An amount equivalent to 1 per cent of the outstanding amount of loan at the end of March each year may be debited to the account in the first week of April on account of guarantee fee and credited to the Government under the Head of Account 0075 –Miscellaneous General Services- 108-Guarantee Fee, under advice to Debt Management Cell in the Finance Department and the concerned Administrative Department. On receipt of this advice, the Debt Management Cell should enter the receipt in the debt management software. If the advice is not received by the end of April, (such cases are expected to be few), the Debt Management Cell should follow up with the bank maintaining the escrow account / concerned Administrative Department. This mechanism would help the government in recovering its dues from the borrower institutions on time. We therefore recommend the use of Escrow account mechanism which has been recommended for timely repayment of loan instalments and payment of interest thereon for recovery of guarantee fee on future issues of guarantees for the years subsequent to the year of issue of guarantee.



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As regards the past dues, there could be cases where the borrowers have not paid the guarantee fee for several years. For recovery of outstanding fee on existing guarantees, first it is essential to know the amount that is payable by each borrower institution. In the present decentralized system of guarantee management, this can be done only by respective Administrative Departments. In order to sensitise the Administrative Departments, Finance Department may address a letter to all the Departments saying that it is observed that guarantee fee actually received in the past years in relation to the amount that ought to have been received on the outstanding amount of guarantees is far too low and it is essential to recover the government dues from the borrowing institutions as early as possible. The Administrative Departments should, therefore, calculate the amount due from each of the borrower institution under its administrative control and submit a statement to the Finance Department showing the name of the institution, the amount recoverable on account of each of the past years within a period of three months. Thereafter the Administrative Departments should initiate steps for the recovery of the past dues. The amount due could be recovered, where feasible, from grants, loans or any other sum which is payable to the borrower institution. We therefore recommend that for recovery of past dues of guarantee fee, the Finance Department may sensitise the Administrative Departments and advise them to calculate the amount of guarantee fee that is recoverable for each of the past years from each of the borrower institutions operating within their respective jurisdiction and submit a statement to the Finance department within three months showing the name of the institution and the amount due year wise. The Administrative Departments, should, thereafter take effective steps for the recovery of outstanding amount. The amount due could be recovered, where feasible, from grants, loans or any other sum which is payable to the borrower institution.



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5. Review of Guarantee Portfolio

The quality of guarantee portfolio can be judged by:

a. Number of defaults by borrower institutions on guaranteed loans and the amount covered by such defaults;

b. Nature of guarantees issued.; and c. Valuation of guarantees in the guarantee portfolio.

There have been defaults by borrower institutions on the guaranteed loans from time to time. The Amount of defaults varies widely from year to year as seen in Table 3: Table 3: Trend in Guarantee Defaults (In Rs Crore)

Year Amount

2003-04 6.002004-05 24.902005-06 227.912006-07 24.352007-08 75.00 (RE)2008-09 85.00 (BE)Source: Book 4 of Budget Document

The defaults made by the borrower institutions, in quite a few cases, became the subject matter of Debt Recovery Tribunal/ High Court and One Time Settlement. The defaults were eventually met by the Finance Department and the amounts paid to the lenders were treated as loans to the borrower institutions. The above statistics do not include defaults, if any, made by borrower institutions which were initially met by the respective Administrative Departments and subsequently recovered from the borrower institutions from grants/ other sums payable to them. Some of the major institutions which account for defaults in their obligations are Madhya Pradesh State Co-operative Oilseed Grower’s Federation Ltd., Madhya Pradesh State Road Transport Corporation, Madhya Pradesh State Land Development Corporation and Madhya Pradesh State Industrial Development Corporation. There were other small units operating under the jurisdiction of Departments such as Commerce & Industry, Cooperation, Agriculture, Power, and Housing & Environment, which could not meet their obligations and the Finance Department had to step in to make the repayments. While going through Volume 5 of Budget Estimates document, it is observed that all guarantees have been issued for a certain fixed amount and for a certain fixed period. Finance Accounts, however, indicate that the state government has issued guarantees on behalf of Madhya Pradesh Electricity Board in favour of Director General of Supplies and Disposals and Railway Board for payment of cost of stores, freight and other dues for an unlimited amount and for an unlimited period. Such guarantees are continuing guarantees and are perpetual in nature. The liability of the government on such guarantees could be any amount. These guarantees were issued in the long past and are not being issued currently. The Madhya Pradesh Electricity Board has since been restructured and many of its functions have been vested in five new companies set up to



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operate independently in the area of generation, transmission and distribution of power in the state. These new companies are expected to carry out their financial operations on the basis of their own strength and pay for the cost of stores and freight like any other independent entity. I We recommend that guarantees issued by the State Government on behalf of Madhya Pradesh Electricity Board to Director General of Supplies and Disposals, and the Railway Board in the long past (Perhaps in 1977) for payment of cost of stores, freight and other dues for unlimited amount and unlimited period may be reviewed with a view to recalling them and cancelling them, on account of recent developments leading to the restructuring of State Electricity Board and setting up of five new companies for generation, transmission and distribution of power in the State which are expected to carry on their financial business on the basis of their own strength and pay for the cost of stores and freight etc. in the normal course without the support of government guarantee. Similarly, Government had issued in the past guarantees on behalf of Madhya Pradesh Financial Corporation for repayment of share capital and payment of 3.5 per cent dividend thereon. These guarantees were also perpetual in nature as the guarantees would remain in force till the share capital was repaid and share capital could not be repaid so long as the Corporation remained in existence. These guarantees were statutory guarantees and the Government could not avoid them. These too were issued in the long past and are no longer being issued now. The central government had amended the State Financial Corporation Act in 2000 whereby every shareholder was given an option to either convert their shares into shares of the same value without state government guarantee or in cash. The option was required to be exercised within a period of three months. If any shareholder did not exercise the option, it was to be construed that they have exercised the option. With this amendment in the Act, the State Financial Corporation is now not expected to have share capital guaranteed by the state government. We therefore recommend that with the enactment of State Financial Corporation (Amendment) Act, 2000 whereby the share capital of all the State Financial Corporations has been converted into share capital not guaranteed by state government, the State Government may recall the guarantees issued by it in the past when the share capital of the Madhya Pradesh Financial Corporation was guaranteed by the state government, and cancel them. On valuation, we have recommended in one of our earlier paragraphs that the government may appoint a credit rating agency for the valuation of the entire guarantee portfolio. It is only upon receipt of the valuation report that a credible opinion can be formed on the quality of the guarantee portfolio.



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6. Standardisation of Guarantee Deed Format

There does not seem to be any standard format prescribed by the government for issue of guarantees by various Administrative Departments. It seems to us that the format of guarantees to be executed by Departments is supplied by the lenders. We collected a few guarantee agreements signed by Departments with different lenders for our study. To ensure that the agreements so chosen represent different classes of lenders, we picked up two samples of guarantees signed with NABARD, two signed with HUDCO and another signed with Central Bank of India. On a close scrutiny of these documents, we have observed that the government has assumed certain unintended liabilities and for an unlimited period in certain cases. These documents also contain clauses which give absolute powers to the lenders much against the interests of the borrower institutions as well as the Government. As an example, Indore Development Fund Ltd., availed of a loan of Rs. 22 crore from HUDCO for financing a Scheme for improvement, widening and strengthening of eight city roads on the terms and conditions set out in the loan agreement dated 19th March, 2008. The loan is to be repaid in 36 quarterly instalments beginning from 30th November, 2009 and ending with 31st August, 2018. The loan has been contracted on a floating rate basis which will be equal to 0.25 % lower than Base Rate. The interest rate at the time of signing the agreement, based on the above formula, was arrived at 10.75% (Base Rate being 11.00%). The lenders have a right to fix the Base rate from time to time. The borrowers are required to pay certain other charges as have been agreed to with the lenders. The Urban Administration & Development Department provided government guarantee to HUDCO after obtaining Cabinet approval. Our observations on this guarantee are as follows:

a. The guarantee agreement provides that the guarantee shall be a continuing guarantee.

There can not be any valid reason for providing a continuing guarantee when the loan has been contracted for a fixed period and a repayment schedule has been drawn up in advance.

b. The guarantee agreement does not specially provide that the loan has been contracted on a floating rate basis. What the agreement says is that the surety guarantees a gross average rate of 10.75 % or such higher interest rate as may be fixed by the lenders. The government liability on the guarantee should have been restricted to the floating rate of interest as per the formula laid down in the loan agreement which could be higher than 10.75% or lower than this rate. The present stipulation is tilted in favour of the lenders and against the government.

c. Guarantee agreement mentions that in case of breach by the borrower of any of the terms and conditions including those contained in the loan agreement, HUDCO may recall the entire loan and if the borrower fails to repay the loan amount, the surety shall pay forthwith the amount. Item 5.3 of Part B of Article 4 (Special Conditions) of the loan agreement gives sweeping powers to HUDCO to change any of the terms and conditions of the loan agreement and their decision shall be final and binding on the borrower. It provides that notwithstanding anything to the contrary contained in this loan agreement, in the sanction letter and in the general conditions, HUDCO shall have the absolute right to change the terms and conditions (including right to negotiate/renegotiate or increase/decrease the rate of interest, penal interest, additional interest, deferment charge, front-end fees, extent of financing, change in repayment period, changed risk



23

perception of HUDCO etc.) pertaining to this loan at any time during the pendency of the loan and HUDCO’s decision in this regard shall be final and binding on the borrower. This kind of clause should not be acceptable as it is capable of changing the liability of the borrower under the loan agreement and that of the government under the guarantee agreement.

d. Article 3 of the loan agreement provides that HUDCO in addition to government guarantee may in its absolute discretion request the borrower to furnish absolute additional security including opening of an Escrow Account/ dedicated account of definite revenue streams with a bank acceptable to HUDCO. Having secured its loan through the government guarantee, this clause was not required as effectively it allows HUDCO additional guarantee.

In another guarantee agreement provided to HUDCO on behalf of MP Financial Corporation for Rs. 25 crore, we find provisions almost similar to the above one. In the case of guarantees provided to NABARD, we find that those are also continuing guarantees. Besides, another notable feature of these guarantees is that they authorize NABARD to request the Reserve Bank of India without any reference to the government, to debit the current account of the government with the amounts due by the borrower on account of principal and/or interest and remit the amount so debited directly to NABARD. To facilitate the implementation of the above provision in the loan agreement, the government is required to issue a mandate to the Reserve Bank of India within a week from the date of signing the guarantee document. We feel that the Government need not provide the facility of automatic debit to their account with the Reserve Bank of India as it indirectly reflects lack of faith either in the ability of the government or its willingness to honour its commitments. The above observations clearly bring out the need to develop a standard format of guarantee agreement in consultation with the Law Department. The format may have flexibilities built into it to allow any particular requirements of any loan agreement. The aforesaid observations do also clearly bring out the need to go through the loan agreements thoroughly by the Administrative Departments before signing them to ensure that they do not undertake any unintended liability, and that the agreements do not contain any clause which is heavily tilted in favour of the lenders which could cause issues for the government later. While drafting the guarantee format, it needs to be ensured that it is fair both to the government as well as the lenders. It is also to be ensured that the document is explicit and not implicit capable of different interpretations. Among others, it should clearly mention the following:

a. Name and address of the borrower institution b. Name and address of the lending institution c. Loan/Bond/Debenture Amount d. Provision for automatic reduction in government liability in case of reduction in loan

disbursement e. Rate of interest-fixed or floating. If floating, basis of calculation. f. Rate of panel interest g. Front-end fee, if any, and how payable h. Deferment Charge, if any



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i. Any other financial charge that the borrower is required to pay j. Repayment Period k. Guarantee period which could be the loan repayment period plus six months to enable

the lenders to enforce the guarantee in case of need. l. General Clauses in regard to payment of guaranteed amount in case of default.

A suggestive list of negative provisions is:

a. Provision for continuing guarantee b. Provision for Escrow Account Mechanism c. Provision for Automatic debt to Government Account in case of default by the borrower

institution d. Absolute powers to lenders to change the terms and conditions of the loan agreement e. Assumption of unintended financial liability

We therefore recommend that the format of Guarantee Agreement may be standardized.



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7. Standardisation of Government Order

Rule 2(v) read with Rule 3 of Guarantee Rules, 1976 stipulates that after obtaining Order-in Council (Cabinet) the administrative department shall issue Government order which shall specify clearly the amount guaranteed, the period of guarantee, rate of interest, whether interest payment is also guaranteed and the rate of guarantee fee. With a view to examining the practice of issuing the above referred Government order, we had collected copies of Government orders issued in the last few years from select administrative departments. On perusal of these Government orders, it is observed that there is no uniform practice followed by administrative departments in this regard. While Finance Department, by and large, is clearly specifying the information required to be specified in the orders, it is not the case with Urban Administration & Development Department, and the Cooperation Department. The Urban Administration & Development Department does not specify most of the information that is required to be specified in the order. The Cooperation Department does not issue any order; it issues a letter addressed to the Registrar specifying the conditions subject to which the guarantee has been approved but without mentioning the information required to be specified in terms of Guarantee Rules. We therefore recommend that the format of the Government Order may be standardized in order to bring in uniformity in the working of various departments of the Government. The departments may be given the freedom to modify the order to meet their specific requirements.



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8. Guarantee Redemption Fund

For meeting the payment obligations arising out of the guarantees issued by the State Government in respect of bonds issued and other borrowings raised by state government undertakings or cooperative bodies or other official agencies and invoked by the beneficiaries, Government of Madhya Pradesh, vide its notification dated 27th January, 2006 has set up a Guarantee Redemption Fund in the Public Account outside the Consolidated Fund of the state. The Fund was initially required to be credited with a contribution of Rs. 3 crore. The Fund is also required to be credited with guarantee fees realised in the preceding year and a matching contribution by the State Government. The balance in the Fund is required to be increased with further contributions by the State Government either annually or at lesser intervals so as to reach a level deemed sufficient to meet the amount of anticipated guarantees devolving on the government as a result of likely invocation of outstanding guarantees. The Fund is administered by Central Accounts Section of Reserve Bank of India subject to the instructions of the state government. The establishment of the Guarantee Redemption Fund is a laudable step taken by the government towards prudent fiscal management. The State Government has contributed over Rs.100 crore every year during the last three years of the establishment of the Fund which clearly demonstrates government’s commitment to the purpose. The balance in the account stood at Rs. 305 crore at the end of 2007-08. With further contributions in future, the Fund would become robust to take care of any guarantee devolvement. We recommend that the State Government may continue to make annual contributions to the Guarantee Redemption Fund and pursue collection of Guarantee Fee for crediting into this fund until a sizeable corpus is built up in the Fund.



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9. Summary of Recommendations

9.1. Legislative Amendments

a. The ambiguity in the provisions of Clause 2 (j) and Clause 9 (2) (d) of the Act may be removed and an appropriate amendment in the Act moved to reflect that these provisions apply to the weighted outstanding guaranteed amount.

b. The State Government may engage a credit rating agency for the valuation of all its outstanding guarantees and in the light of the results of such valuation assign the weights as recommended by the Technical Committee set up by the Reserve Bank of India and then include the weighted outstanding guarantee obligations in the total liabilities. It would bring down the ratio of total liabilities to GSDP.

c. As a measure of economic sector reforms and with a view to strengthening performance management in government, we recommend that Clause 9 (2) (d) of the FRBM Act, 2005 may be amended to limit the outstanding guaranteed amount to 50 per cent of the total revenue receipts in the year preceding the current year.

9.2. Policy, Procedure and Management Framework

a. The work relating to issuance of guarantees may be centralised and the responsibility of execution of government guarantees, maintenance of guarantee data and guarantee documents, and monitoring of timely payments on guaranteed loans and taking timely remedial measures, wherever called for, etc. may be entrusted to the Debt Management Cell in the Finance Department, for better and more effective control on government guarantees.

b. In order to simplify the guarantee process, the requirement of Administrative Department executing agreement with the borrowing institution as stipulated in Rule 5 of Guarantee Rules, 1976 may be done away with. Instead, a composite Guarantee Request Application Form may be developed in which the borrowing institution should provide the information contained in Rule 2 and furnish an undertaking agreeing to do all that is contained in Rule 5 of Guarantee Rules, 1976. This would reduce the work of the Administrative Departments and at the same time protect the financial interest of the Government.

c. To support the centralised system, the guarantee issuance procedure may be adopted as shown in Figure 2

d. In order to ensure timely repayment of loan instalments and payment of interest on their due dates by the borrowing institution and thereby reduce, if not eliminate altogether, the devolvement of guarantees on the government, Guarantee Rules may be amended so as to provide for opening of an Escrow account by the borrowing institution with a nationalized bank/ state owned bank which would be pledged in favour of the lending institution and in which all the receipts, collections and income of the borrowing institution would be credited and the balance in the account would first be utilized to meet payments associated with loan liability.

e. A negative list indicating the purposes for which and the institutions to which guarantee will not be provided may be finalized and incorporated in the Guarantee Rules for the guidance of Administrative Departments. The negative list, illustratively, may include that guarantees would not be issued for cash credit accommodation, working capital, and for



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repayment of share capital and payment of dividend, and for and on behalf of individuals and private institutions and those public sector undertakings and official agencies which have either defaulted payments on guaranteed loans during the last five years or which have not finalized the accounts and have not got them audited for the last at least two preceding years.

f. The format of Guarantee Agreement may be standardized g. The format of the Government Order may be standardized in order to bring uniformity in

the working of the various departments of the Government. The departments may be given the freedom to modify the order to meet their specific requirements.

h. All guarantees may be allotted a serial number preceded by the year in which they are issued, and the serial number so allotted should be incorporated on the guarantee agreement for easy identification and cross referencing. This is implementable if the guarantee issuance work is centralised as recommended.

9.3. Computerisation of Guarantee Data

a. Guarantee data may be computerized. The past guarantee data, as a one-time exercise, may be collected from Administrative Departments and loaded on to the debt management system . The data would need to be collected in the format which is compatible with the debt management software system by making house-to-house calls, wherever necessary, to complete the project expeditiously. All future guarantees should be entered in the system at the time of their issue itself in order to maintain the system up-to-date. The guarantee liability may be cross checked with the lenders to the extent possible.

b. Finance Department may develop a computerized mechanism to monitor payments on guaranteed loan liabilities by borrowing institutions, with output from the debt management system after it is installed and past guarantee data is captured therein, with a view to initiating timely remedial measures in case of any likelihood of any guarantee devolving on the government.

9.4. Review of Certain Guarantees

a. Guarantees issued by the State Government on behalf of Madhya Pradesh Electricity Board to Director General of Supplies and Disposals, and the Railway Board in the long past (Perhaps in 1977) for payment of cost of stores, freight and other dues for unlimited amount and unlimited period may be reviewed with a view to recalling them and cancelling them, on account of recent developments leading to the restructuring of State Electricity Board and setting up of five new companies for generation, transmission and distribution of power in the State which are expected to carry on their financial business on the basis of their own strength and pay for the cost of stores and freight etc. in the normal course without the support of government guarantee.

b. With the enactment of State Financial Corporation (Amendment) Act, 2000 whereby the share capital of all the State Financial Corporations has been converted into share capital not guaranteed by state government, the State Government may recall the guarantees issued by it in the past when the share capital of the Madhya Pradesh Financial Corporation was guaranteed by the state government, and cancel them.



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9.5. Guarantee Fee

a. Escrow account mechanism which has been recommended for timely repayment of loan instalments and payment of interest thereon may be used for recovery of guarantee fee on future issues of guarantees for the years subsequent to the year of issue of guarantee.

b. For recovery of past dues of guarantee fee, the Finance Department may sensitise the Administrative Departments and advise them to calculate the amount of guarantee fee that is recoverable for each of the past years from each of the borrower institutions operating within their respective jurisdiction and submit a statement to the Finance department within three months showing the name of the institution and the amount due year wise. The Administrative Departments, should, thereafter take effective steps for the recovery of outstanding amount. The amount due could be recovered, where feasible, from grants, loans or any other sum which is payable to the borrower institution. Monitoring of realisation of arrears of guarantee fee may be entrusted to the Debt Management Cell.

9.6. Revision of Guarantee Rules, 1976

To make the Guarantee Rules, 1976 comprehensive and transparent, a thorough revision may be undertaken:

a. to incorporate therein suitably the provisions of FRBM Act, 2005 relating to ceiling on

guarantees, b. to provide that the ceiling on guarantees would be worked out by the Finance Department

every year in accordance with the provisions of the FRBM Act, 2005 in the beginning of each financial year and communicated to all the Administrative Departments and the Accountant General. This is necessary to ensure that the officials do not breach the ceiling while issuing guarantees,

c. to provide for opening of an Escrow Account by the borrowing institution for payment of loan dues and for payment of guarantee fee,

d. to incorporate a negative list indicating the purposes for which and the institutions to which guarantee will not be provided,

e. to incorporate issue of guarantee in the standard format which could be modified to meet the specific needs,

f. to incorporate format of Guarantee Request Application Form, g. to provide for creation of pari pasu first charge on the immovable assets of the borrowing

institution in order to better protect the interests of the government, h. to provide for the rate of guarantee fee and the manner and the period within which the

guarantee fee is payable, i. to provide that powers to grant exemption from payment of guarantee fee rests with the

Cabinet, j. to incorporate consequential changes arising out of the decisions that may be taken by the

Government on our recommendations.

9.7. Guarantee Redemption Fund

The State Government may continue to make annual contributions to the Guarantee Redemption Fund until a sizeable corpus is built up in the Fund.



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10. Way Forward

The following actions may be considered by GoMP towards implement of recommendations in this report:

a. Amend the Madhya Pradesh Rajkoshiya Uttardayitva Evam Budget Prabandhan

Adhiniyam, 2005 as detailed in section 9.1 b. Appoint a credit rating agency for valuation of guarantees. c. Approve centralisation of issue and management of guarantees in the Debt Management

Cell in the Finance Department. d. Approve the revised guarantee issue procedure. e. Approve opening of Escrow account by the borrower institution. f. Approve elimination of execution of agreement by Administrative Department with the

borrowing institution. g. Finalise a negative list indicating the purposes for which and the institutions to which the

guarantee would not be provided. h. Review guarantees issued in the long past on behalf of MP Electricity Board and MP

Financial Corporation. i. Outsource the following activities:

• Computerisation of guarantee data including collection thereof by making house-to-

house calls, wherever necessary, and cross checking of liability with the lenders. • Development of a computer based guarantee monitoring mechanism. • Development of a standard format of Guarantee Deed. • Redrafting of Guarantee Rules, 1976.

j. Develop a composite Guarantee Request Application Form. k. Develop a standard format of Government Order.



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Disclaimer

The primary purpose of this Report and its contents is to present the various issues and recommendations related to Management of Guarantees of Madhya Pradesh Government to the Department of Finance, GoMP and to the Department for International Development, United Kingdom prepared under the Strengthening Performance Management in Government Programme.

The contents of this report are based on the facts, assumptions and representations stated herein. Our assessment and opinions are based on the facts and circumstances provided/collected during our meetings with the officials of Government of MP, DFID and research from sources in public domain held to be reliable. If any of these facts, assumptions or representations is not entirely complete or accurate, the conclusions drawn therein could undergo material change and the incompleteness or inaccuracy could cause us to change our opinions. The assertions and conclusions are based on the information available at the time of writing this report and PwC will not be responsible to rework any such assertion or conclusion if new or updated information is made available.

PwC disclaims all liability to any third party who may place reliance on this report and therefore does not assume responsibility for any loss or damage suffered by any such third party in reliance thereon.

This report is provided on the basis that it is for the use of DFID and Government of MP only and that it will not be copied or disclosed to any third party or otherwise quoted or referred to, in whole or in part, without PwC’s prior written consent. Furthermore, PwC will not be bound to discuss, explain or reply to queries raised by any agency other than the intended recipients of this report.

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