RBI wants cap on state guarantees

Feb 3: The Reserve Bank of India RBI has called for placing of an upper limit on the level of guarantees to be extended by each state g...

Feb 3: The Reserve Bank of India RBI has called for placing of an upper limit on the level of guarantees to be extended by each state government and also maintenance of separate guarantee funds to meet contingencies in the event of non-compliance of obligations. The RBI has called upon the state governments to cut non-merit subsidies and raise user charges for fiscal consolidation.

8220;The rationale and level of guarantees provided by state governments would need to be examined in detail for its implications on state finances in the event of default,8221; RBI said in a supplement on Finances of state governments: 1998-998242; to the February 1999 bulletin.

To place an upper limit on the level of guarantees to be extended by a state, in order to provide confidence to the markets that the state finances are well managed given the fact that market borrowings would continue to reflect market conditions.

The RBI noted that in the post-reform period, the growing need for infrastructure at the state level and needfor participation by private sector in such projects requiring huge investments has put further pressure on state governments to stand guarantor for such projects.

The element of risk associated with such guarantees, transparency with regard to the guarantee policies and present magnitude of guarantees extended by state governments have raised concerns regarding the optimal and sustainable level of such guarantees, keeping in view the fiscal health of state governments.

The RBI has called upon the state governments to cut non-merit subsidies and raise user charges for fiscal consolidation. The central bank has also hinted at reviewing the system of ways and means advances WMA provided by RBI to states for meeting the temporary mismatches in their receipts and payments. Despite a doubling of the limits of WMA in August 1996, a number of states have continued to be plagued by problems of cash management and have frequently been in overdraft, RBI said.

According to the central bank, the responsibility ofsocial and basic infrastructure development on the state governments is high and it is in these sectors, rates of return are relatively low. With state public sector undertakings running into losses, the state governments have limited choices to make, RBI admitted.

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The options before the state governments are: reduction in non-essential expenditures, widening the tax base, raising the user charges, and cutting down subsidies wherever warranted.

Cutting down non-essential expenditures is not easy as a high proportion of the non-developmental expenditures are non-plan in nature, which are sticky downward, RBI said. Augmenting resources through states8217; own tax and non-tax measures depends on the extent of success of tax restructuring and rationalisation. Some state governments have favoured a move towards harmonisation of inter-state taxes, it said.

On the non-tax front, the issue of implicit subsidies has to be resolved with accent placed on user charges. The WMA extended to the states is only for meetingtemporary mismatches in receipts and expenditure and should not be viewed by states as a source of financing their structural imbalances, RBI said.

The RBI said issues concerning federal-fiscal transfers have to be focussed on keeping in view the changing role of the states in socio-economic development. In this context, considerable importance would have to be attached to the recommendations of the Eleventh Finance Commission, set up in July 1998 to work out the modalities of transfers from Centre to states and from consolidated funds to local bodies.