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Surge in State Loan Guarantees: Fiscal Risks and Investor Impacts

Surge in State Loan Guarantees: Fiscal Risks and Investor Impacts

Source and Citation: News article from PTI published on Jan 22, 2024.

Analysis for Layman

The report reveals a significant increase in guarantees provided by 17 major Indian states to state-owned entities, rising from Rs 3 lakh crore in FY17 to Rs 9.4 lakh crore by FY23 – a threefold increase over the past five years. While guarantees are not immediate liabilities unless invoked, they present fiscal risks for states. Proposed RBI rules aim to regulate the issuance of guarantees, introducing caps on yearly issuances and charging fees based on risk levels.

Surge in State Loan Guarantees: Fiscal Risks and Investor Impacts

Impact on Retail Investors

For retail investors, the surge in state guarantees suggests emerging medium-term risks:

Fiscal Strain

Higher contingent liabilities may strain state finances if invoked, potentially leading to risks of sovereign downgrades. This could limit funds available for welfare spending.

Borrowing Costs

The increase in guarantees may lead to higher state development loans and bond yields, affecting state debt levels and increasing borrowing costs.

However, the proposed RBI rules are expected to cap guarantees, reducing risks. Investors should adopt a wait-and-see approach by monitoring state finances for signs of strain and watching for rating actions on state debts.

Impact on Industries

Public Sector Enterprises

Tighter scrutiny may constrain fundraising abilities for weak state PSUs, pushing for performance improvements.

Banking

With over 50% exposure, banks need to be more aware of risks in lending backed by state guarantees. They may face some loss in competitive positioning compared to private banks.

Infrastructure

Slower guarantees may impact state infra firms raising funds, but it ensures greater transparency and financial viability checks.

Power, Irrigation, ULBs

Key sectors receiving high guarantees for financial viability may face challenges in capex and require more budgetary support, but this reduces long-term risks.

Long Term Benefits & Negatives

Positives:

  • Improved fiscal responsibility and budget management of states.
  • Reduction of moral hazard in issuing unlimited guarantees without risk assessment.
  • Safeguarding state finances against unviable projects extracting guarantees.
  • Better governance and financial viability checks before funding access.

Negatives:

  • Potential slowdown in growth for state infrastructure firms and utilities.
  • Overall impact on infrastructure development if guarantee availability is curbed.
  • States may need to infuse more direct equity, diverting resources.

While some growth headwinds exist, the financial stability benefits outweigh near-term issues.

Short Term Benefits & Negatives

Positives:

  • Positive signal about fiscal prudence with the curbing of runaway guarantees.
  • Boost in investor confidence that state budget risks will be contained.
  • Stability for banks as they recalibrate state exposure seeing discipline in guarantees.

Negatives:

  • Slowdown in infrastructure projects as norms tighten.
  • Financial stability risks for weak state PSUs/utilities with reduced guarantee access.
  • Moderation in state spending as more budget funds are needed for equity support.

For investors, the near-term impact looks manageable, but monitoring is necessary as states adjust to new guarantee rules. Bank stocks with high state exposure may face portfolio risks, but improved transparency is expected from states.

Companies Impacted by New State Loan Guarantee Rules

Indian Companies Potentially Impacted:

Public Sector Undertakings (PSUs): Increased scrutiny and stricter criteria for guarantees could make it harder for PSUs to access cheap credit through state guarantees. This could impact companies like Coal India, ONGC, Air India, and others currently relying heavily on such guarantees. Reduced access to financing could lead to slower growth or delayed projects, potentially impacting their share prices.

Banks and Financial Institutions: The report’s recommendations for lenders to assess loans critically, even with a guarantee, could lead to stricter loan terms and higher borrowing costs for state-owned entities. This could potentially benefit banks by reducing their exposure to potential bad loans. However, it might also lead to lower loan volumes for banks with significant exposure to PSUs.

Construction and Infrastructure Companies: Projects relying on state guarantees for financing might face delays or cancellations due to stricter criteria. This could impact companies like Larsen & Toubro, Afcons Infrastructure, and others involved in infrastructure projects backed by state guarantees.

Indian Companies Less Impacted:

Private Companies: The news primarily impacts PSUs and state-owned entities. Private companies not reliant on state guarantees might see less direct impact.

Companies with Strong Financials: Companies with strong balance sheets and alternative funding options might be less impacted by stricter guarantee rules.

Global Companies Less Impacted:

Global Financial Institutions: While the news primarily concerns domestic lending, global financial institutions might see limited direct impact unless significantly involved in lending to Indian PSUs.

Disclaimer: This analysis is based on the information provided in the news article and should not be considered financial advice. It is recommended to conduct thorough research and consult with a financial advisor before making any investment decisions.

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