The popular adage, “Nurse the baby, protect the child, and free the adult”, has often been quoted as part of infant industry argument. Amid global uncertainties from the pandemic, potential wars, and trade disruptions, economies worldwide are turning inward in a bid to protect domestic industries.
Over the last few Budgets, the government of India has been pushing for guarantees like Credit Guarantee Fund Trust for Micro and Small Enterprises , Pradhan Mantri Mudra Yojana, Pradhan Mantri Garib Kalyan Yojana, Emergency Credit Line Guarantee Scheme (2020), Startup India Seed Fund Scheme (2021), Stand-Up India Scheme (2016 – Enhanced post-2018), Kisan Credit Card Scheme, Atmanirbhar Bharat Abhiyan Credit Guarantee Scheme (2020) especially to buttress the relatively burdened sectors, encourage smaller firms agricultural farmers and women entrepreneurs in their progress.
The latest Budget has also extended the credit guarantee cover for MSMEs from ₹5 crore to ₹10 crore. However, the concerning issue is whether government backed guarantees will become a norm in lending processes.
Based on Reserve Bank of India statistics (see chart), there has been a consistent rise in secured loans with government backing in public sector banks. What is interesting to note is the rising gap in such loans between the public sector and private sector banks. Guarantees have been a ploy used by governments across the world in the recent past to avert any contemporaneous fiscal damage, with there being no cash outflow but intended towards improving the liquidity and solvency parameters of the ailing firms.
While the Opposition cries foul over allegations of crony capitalism from time to time, the government has used the falling ratio of non-performing assets to advances across the public sector banks in its defence. Interestingly enough, the share of provisions for such bad debt has also been reducing across public sector banks, perhaps with increasing confidence with respect to its borrowers.
But given that the supply-chain bottlenecks should have subsided post the pandemic, the rising rate of government guarantees raises concerns on the consequences of such a process. Given the potential risks, should the government shift its focus from guaranteeing loans for large firms to prioritising start-ups and MSMEs, despite the higher likelihood of default in these sectors?
Focus areas
Firstly, the monitoring, verification and reporting standards of public sector banks need to be robust especially on these categories of secured loans. Any laxity on those fronts could lead to distortion in the behaviour of banks by taking unnecessary risks in extending both guaranteed and non-guaranteed loans without independently evaluating the credibility of its borrowers.
Secondly, the government also bears risk on the adverse materialisation of these liabilities in future if the supported borrowers default on their loans.
Thirdly, it is important to recognise whether the guarantees have actually resulted in reduction of information asymmetry and high transaction costs on loans for the SME borrowers. The need to move to higher quality of accrual and cash-flow accounting information needs to be considered for usage of guaranteed government loans.
Further, government support should not necessarily be policy driven but be part of merit-based assessments, especially in the context of start-up financing. Thus, targeted government guarantees can support private credit market friction, particularly in areas of limited financial institutional capital along with assessment of soft measures such as corporate ethics, governance capacity and leadership styles of owners.
More importantly, many of these guarantees could underscore the relative importance of marginal social value compared to marginal private value, such that they provide positive externalities to the society. For example, government backed guarantees in projects which address climate change concerns and promote research and development expenditure across firms could be encouraged. In addition to the Union playing its part in guarantees, the States have joined hands from time to time, especially to the beleaguered state-owned enterprises to fund many of the infrastructure projects. The invocation of guarantees by the banks could spell trouble for the government, if these firms fail to stand up on their own feet. Additionally, alternatives such as counter guarantees for large firms could be considered to mitigate such risks.
While the Fiscal Responsibility and Budget Management Act restricts the Central Government to extend guarantees up to 0.5 per cent of GDP in any financial year, there is no concise definition around the informal form of implicit support by the government. The government has used guarantees as a substitute for direct public investment in infrastructure in a bid to curtail fiscal deficit.
However, guarantees pose technical difficulties for both financial reporting and statistical accounting disclosures. This requires transparency in disclosing the range of budgetary outcomes and their expected probabilities, to help assess the decision of whether or not to recognise the liability in the Budget accounts.
Chakrabarty is Assistant Professor, IIM Lucknow, and Bhattacharya is Postdoctoral Fellow, IIT Kanpur