Research Report No.

/2022-23

Kengeri Post, Bangalore-Mysore Road, Bengaluru-560060

Phone:+91 80 26971000, Fax: +91 80 26971010,
e-Mail: director[at]fpibangalore[dot]gov[dot]in

Research Report

On

GOVERNMENT GUARANTEES IN KARNATAKA

IMPLICATIONS FOR FISCAL POLICY

Dr. Gunabhagya
Research Fellow

2023
 Acknowledgement
I would like to thank the Fiscal Policy Institute for the opportunity to conduct policy
relevant research under the mentorship of Dr. M R Narayana. I also extend my gratitude to the
institute director for their constant encouragement and support throughout the research process.
I am also thankful to the Research Advisory Committee Members, Prof. Meenakshi
Rajeev, Institute for Social and Economic Change and Mr. D. P. Prakash, Executive Director,
Karnataka State Industrial and Infrastructure Development Corporation, GOK, for their expert
comments and suggestions.

I would also like to thank the officers of Directorate of pension Small Savings and Asset
Liability Monitoring, GOK for sharing the requested information.

I am grateful to the administrative authorities and staff for their constant assistance, as
well as the library staff for making facilities available for research.

Dr. Gunabhagya
Research Fellow
FPI
 Executive Summary
Empirical analysis of default risk associated with government guarantees and its impact on
contingent liabilities for government of Karnataka is major objective of this report. Prudent
management of guarantees is crucial for maintaining fiscal discipline in state government,
because, these guarantees are contingent liability to the government. Based on the empirical
issues identified in the policy analysis, this study is confined to the following objectives: a)
analysis of size, trends and composition of government guarantees, b) analysis of impact of
default risk in government guarantees on fiscal policy and c) to draw implications on
government guarantees as an instrument of good fiscal management through management of
contingent liabilities.

The analysis of government guarantees for the period 2016-17 to 2020-21 indicates a
significant increase in total outstanding guarantees and its share to total liabilities in the state.
On an average, total outstanding government guarantee in the state has grown by 16.42 percent
per year and its compound annual growth rate remained at 15.78 percent. Out of various
departments and boards, Water Resource Department holds nearly 49 percent of the total
outstanding guarantee as on 31st March 2021.

This report has also analysed the impact of guarantees default risk on total liabilities following
the recommendations of the 15th Finance Commission. Government guarantees given to public
sector enterprises, cooperatives, boards, etc. are contingent liabilities and only upon the
invocation which can be due to default on payment of interest and/or principal amount are they
considered a liability for the government. For purposes of this study, the guarantees are risk
classified into low, medium, high and very high which have a risk weight of 0, 20, 60, 80 and
100 per cent respectively. The analysis finds that there has been a marked shift towards
provision of guarantees to high-risk category.

The economic crisis unfolded by the Covid-19 pandemic may have a negative impact on the
economic performance of these guaranteed entities and there may be chances of default or
increase in guarantee amount during the medium term. The analysis calculated the expected
losses and unexpected losses from these guaranteed organizations based on the probability of
default using the risk criterion. The inclusion of expected losses increased the total liabilities
to 25.37 percent of GSDP for the year 2020-21 from 24 percent. While the inclusion of only
expected losses is advisable to the total liabilities as it is more prone to occurrence, the
unexpected losses can be off-set by setting aside the guarantee commission received from the
guaranteed organizations. Instead of allocating funds towards the Guarantee Redemption Fund
as recommended by the 15th Finance Commission, GOK can utilize the guarantee commission
towards the creation of guarantee redemption fund.

Overall, results show a higher guarantees are given towards the high risk category entities as
compared to low risk category entities, Hence, it is necessary to advise high risk entities
towards more appropriate management of financial aspects so as to shift them from high risk
to medium and then low risk entities. As per schedule III of Companies Act, 2013, the company
should disclose the performance ratios. These ratios can be used as criteria for granting
guarantees for working PSUs in future.

The risk causing factors of high risk entities must be focussed to avoid the future unanticipated
fiscal risk. Non-commercial entities, which are operating on welfare orientation, or working in
non-competitive environments may be exempted from and risk based contingent analysis.

To avoid the fiscal burden of government guarantees, apart from revenue items in the balance
sheet, newer sources of internal revenues may be explored. Lessons for the past good practice
of companies, which availed the loans through government guarantees and repaid entire
amount, may be useful for present and future for successful management of government
guarantees.

As per CRISIL study, the risk factors and triggers by individual PSUs are identified for risk
categorisation and demonstration of risk weights. These risk factors may be taken note as
decision criteria for granting government guarantees for the PSUs in future.
Contents
CHAPTER-1: INTRODUCTION ....................................................................................................... 1
1.1 Introduction ................................................................................................................................... 1
1.2 Overview of government guarantees in Karnataka ....................................................................... 2
1.3 Public Funds of PSUs ................................................................................................................... 2
1.4 Brief review of related literature ................................................................................................... 4
1.5 Objectives of the Study ................................................................................................................. 5
1.6 Methodology ................................................................................................................................. 5
1.8 Organization of the report ............................................................................................................. 8
CHAPTER-2: GOVERNMENT POLICY ON GUARANTEES IN INDIA: AN OVERVIEW .... 9
2.1 Constitutional Provisions .............................................................................................................. 9
2.2 Policy Structure 1950-1999 .......................................................................................................... 9
2.3 Need for regulating government guarantees in India .................................................................. 11
2.4 The Karnataka Ceiling on Government Guarantee Act, 1999 .................................................... 12
2.5 RBI Report to assess the Fiscal Risk of State Government Guarantees- July 2002 ................... 15
2.6 Recent Developments ................................................................................................................. 15
CHAPTER-3: TRENDS IN SIZE AND COMPOSITION OF GOVERNMENT GUARANTEES
IN KARNATAKA ............................................................................................................................... 17
3.1 Size of government guarantees and liabilities............................................................................. 17
3.2 Growth of guarantees in Karnataka ............................................................................................ 19
3.3 Composition of Government guarantees in Karnataka ............................................................... 21
CHAPTER-4: DEFAULT RISK IN GOVERNMENT GUARANTEES ....................................... 23
4.1 Objectives of the chapter............................................................................................................. 23
4.2 Risk assessment: International perspectives ............................................................................... 23
4.3 Framework for fiscal risk analysis of government guarantees in Karnataka .............................. 24
4.4 Cost of guarantees by assessment of rate of interest and size of borrowing ............................... 24
4.5 Calculation of default risk and probable losses........................................................................... 28
4.6 Impact of government guarantees on total liabilities in GOK .................................................... 32
CHAPTER-5: MAJOR FINDINGS AND POLICY SUGGESTIONS........................................... 34
5.1 Major findings ............................................................................................................................. 34
5.2 Policy implications...................................................................................................................... 35
ANNEXURE ........................................................................................................................................ 39
REFERENCES .................................................................................................................................... 46
 List of Tables

Table No. Particulars Page

No.
Table-2.1 Guarantee commission slab rate, 1966 in Government of Karnataka 10
Table-3.1 GOK’s guarantees in national context: 2016-17 to 2021-22 18
Table-3.2 Growth of government guarantees in Karnataka: 2010-11 to 2021-22 21
Sectoral Distribution of Government Guarantees in Karnataka (as on
Table-3.3 22
March 2021)
Cost of government guarantees by interest rate at the end of March
Table-4.1 26
2021: Karnataka
Table-4.2 Size of guarantee commission by interest rate by the end of March 2021 27
Size of guarantee commission by PSUs in Karnataka (end of March
Table-4.3 29
2021)
Table-4.4 Risk category of government guarantees in Karnataka 30
Calculation of losses associated with government guarantees in
Table-4.5 32
Karnataka as on March, 2021

List of Figures
Figure Particulars Page
No. No.
Size and share of Government Guarantees at all India level: 2010-11 to
Figure-1 19
2021-22
Size and share of Government guarantees to in Karnataka: 2010-11 to
Figure-2 20
2020-21
Average. Outstanding guarantees - As percentage of Average liabilities
Figure-3 20
for major states (2016-17 to 2021-22)
Annual growth rate of outstanding government guarantees in Karnataka
Figure-4 21
(2011-12 to 2021-22)
Impact on total liabilities from inclusion of expected losses from
Figure-5 34
government guarantees, 2020-21, Karnataka
List of abbreviations
1. PSUs: Public Sector Undertakings
2. GC: Guarantee Commission
3. UDAY: Ujjwala DISCOM Assurance Yojane
4. DISCOMs: Power Distribution Companies
5. KSFC: Karnataka State Financial Corporation
6. KPC: Karnataka Power Corporation Limited
7. PCKL: Power Company of Karnataka Limited
8. HESCOM: Hubli Electric Company Limited
9. GESCOM: Gulbarga Electric Company Limited
10. MESCOM: Mangalore Electric Company Limited
11. BESCOM: Bangalore Electric Company Limited
12. CESCOM: Chamundeshwari Electric Company Limited
13. KUWSDB: Karnataka Urban Water Supply & Drainage Board
14. BWSSB: Bangalore Water Supply & Sanitation Board
15. KPCL: Karnataka Power Corporation Limited
16. KHDC: Karnataka Handloom Development Corporation
17. KRDCL: Karnataka Road Development Corporation Limited
18. KNNL: Karnataka Neeravari Nigama Limited
19. KBJNL: Krishna Bhagya Jala Nigama Limited
20. CNNL: Cauvery Neeravari Nigama Limited
21. VJNL: Vishveshwarya Jala Nigama Limited
22. NMDFC: National Minorities Development and Finance Corporation
23. NHFDC: National Handicapped Finance and Development Corporation
24. NBCFDC: National Backward Classes Finance & Development Corporation
25. NSTFDC: National Schedule Tribes Finance and Development Corporation
26. NSCFDC: National Schedule Caste Finance and Development Corporation
 CHAPTER 1
INTRODUCTION

1.1 Introduction

A guarantee refers to an agreement to pay another person’s debt if that person fails to do so or
to ensure the performance of some other obligation by another person. In this sense, a guarantee
(suretyship) is always a secondary obligation (Goode 2014 and Donovan and Phillips 2003).
Government extends guarantees to public bodies for the loans they borrow from different
financial institutions.

In general, government guarantees to financial institutions are thought to have a positive role
in promoting investments in investors/financial institutions, and help to stabilize the financial
system. Despite the benefits, however they can cause a substantial burden on fiscal health of
governments in future unless they are prudently managed.

Guarantees are contingent liabilities that can expose the issuing government to significant fiscal
risks. Unless issued prudently and managed effectively, when called, guarantees can cause a
substantial burden on government budget, resulting in a large unanticipated cash outflows and
increased debt. The contingent liabilities have been increasing in recent years. As per the latest
information, the off-budget borrowings by the states-loans raised by state-owned entities and
the guaranteed by the state governments have reached around 4.5 percent of the GDP in 2022
(CRISIL, 2022). While the power sector accounts for almost 40 percent of these guarantees,
other beneficiaries include sectors like irrigation, infrastructure development, and food and
water supply (Mukherjee, 2022).

Brixi (1998) classified contingent liabilities into two type’s viz., Explicit Contingent Liabilities
and Implicit Contingent Liabilities. Explicit liability is recognized by law or contract whereas
implicit obligation of the government mainly reflects public expectations. State guarantees
issued on behalf of sub-national governments and public and private sector entities fall in the
category of explicit contingent liabilities. Bank failures (support beyond state insurance),
liability clean up in entities being privatised, failure of non-guaranteed pension funds or other
social security funds, default of central bank on its obligations and collapse due to sudden
capital outflows are comes under the category of implicit liabilities. This report is focussed on
economic policy analysis of explicit liability of government guarantees of Government of
Karnataka.

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1.2 Overview of government guarantees in Karnataka

Government of Karnataka (GOK) issues guarantees on behalf of State Public Sector

Undertakings (PSUs) and other State-owned Companies under the control of various
Administrative Departments to enable them to implement developmental schemes/projects.
Karnataka state’s Public Sector Undertakings (PSUs) consist of Government Companies (GCs),
Statutory Corporations (SCs), and Co-operative Societies.

The main objectives for setting up the public sector undertakings are to: a) Help in rapid
economic growth and industrialization and create necessary infrastructure for economic
development; b) Earn a return on investment and thus generate resources for development; c)
Promote redistribution of income and wealth; d) Create employment opportunities; e) Promote
balanced regional development; and f) Assist in development of small-scale and ancillary
industries operating in the state.

At present, as per the Comptroller and Audit General of India (CAG) report, in March 2021,
124 PSUs are functioning in the state. Of these, 6 are Statutory Corporations and 13 are non-
working government companies. Out of the total PSUs, Karnataka has 70 government
companies incorporated under India’s Companies Act, including 14 non-working companies, 6
statutory organizations established under other Central Government Acts, and Co-operative
societies under the Societies Act. These entities are generally owned by GOK and in few cases
jointly with Government of India (GOI). A wide range of commercial and developmental
activities are taken up by these entities, such as, power, irrigation, urban infrastructure
development, financial institutions, and development of specific communities like schedule
cast, tribes, women, and minorities. The largest sectors are power sector, road transport, finance,
and irrigation.

1.3 Public Funds of PSUs

GOK provides financial assistance to the PSUs in three ways viz., 1) Share capital and loans.
2) Special financial support - by way of grants and subsidies to the PSUs as and when required,
and 3) Guarantees – for repayment (with interest) of loans availed by the PSUs from financial
institutions.

As of March 2019, of the total investment in state PSUs, 99.59 percent was working PSUs and
the remaining 0.41 percent was non-working PSUs. This total investment was made up of 55.33
percent share capital and 44.67 percent long-term loans. During the financial year 2018-19,

2
nine PSUs availed government guarantees of Rs. 4,472.75 crores. The corporations in power
sector like Raichur Power Corporation Ltd, Karnataka Power Corporation, Gulbarga Electricity
Supply Company Ltd and Chamundeshwari Electricity Supply Company Ltd and in other than
power sector, Karnataka Neeravari Nigama Ltd, and Bangalore Metropolitan Transport
Corporations are incurring operational losses (CAG, Audit Report 2018-19). The negative net
worth of the entities that are often funded by the State Government are a form of contingent
liability to government. The State Government also invested in 113 PSUs as share capital and
equity funds in 2022-23.

In 2022-23, 48, PSUs have outstanding guarantees, lesser than in previous year (52 PSUs). Of
the total, 10 statutory corporations and boards, 22 government companies, and 16 co-operative
societies and other institutions make up part of the total. Out of which, 21 PSUs were audited
by CAG during 2019–20. (6 statutory corporations and 15 government companies). During the
financial year 2022-23, 22 PSUs availed the government guarantees as well as share capital. Of
these, 19 PSUs were audited by CAG.

Contingent liabilities unless managed well can devolve onto the state budget in an unanticipated
manner resulting in cash-outflows and debt build-up. Hence, GOK has taken initial steps
towards the imposition of a cap on guarantees for promoting fiscal discipline in the state by
enacting the Karnataka Ceiling on Government Guarantees Act, 1999 (Karnataka Act 11 of
1999). The outstanding guarantees at the end of all financial years from 2017-18 to 2020-21
have always been within the prescribed limits as per the Karnataka Ceiling of Government
Guarantees Act 1999. But the percentage of the outstanding amount guaranteed to total revenue
receipts of the second preceding year had increased from 15.5 percent to 19.8 percent for the
above respective FY. This increase may eventually lead to fiscal effects in terms of higher total
liabilities.

When guarantees are not valued, a government may choose to provide a guarantee instead of a
subsidy even when the former is more costly, because the costs of guarantee are hidden and
may be borne by a future administration (Thobani, 1999). Brixi, et al., (2000) Thus, default risk
associated with each of the guarantees should be assessed carefully and estimated before the
issuance. In case the government has issued a large number of similar guarantees for many
years and has recorded information on defaults, expected cost of guarantees should be estimated
to avoid future risk (Hsueh and Kidwell, 2008). The most common source of contingent
liabilities is troubled financial institutions, state-owned enterprises, subnational governments,

3
private non-financial companies, and PPPs. There is a widespread public expectation that the
government will rescue these entities in case of a default, hence they will approach the
government for guarantees. Hence, it is advised that the government should analyze the
financial position of particular entities before granting the guarantees (IMF, 2016). The
government needs to conduct fiscal risk analysis, Vulnerability, and stress tests regularly by
using specific risk mitigation strategies to manage fiscal risks efficiently (Mukherjee, 2022).

1.4 Brief review of related literature

The RBI's study of state finances (2021) emphasized the importance of assessing the impact of
the potential realization of contingent liabilities of government guarantees in the post-pandemic
period, which poses a risk to debt sustainability due to increased borrowings and the
concomitant increase in servicing costs.

The study by Mishra, Gupta, & Trivedi (2020) also highlighted the importance of accounting
for government guarantees, especially those of power distribution companies (DISCOMS) for
accurate calculation of liabilities. In the international context, studies by Currie & Velandia
(2002), Irwin & Mokdad (2010) identify the risk associated with accepting contingent liabilities
by national governments. These liabilities create financial obligations for the governments and
lead to fiscal imbalance if unchecked

The study by RBI (2002) highlighted the importance of examining the role of government
guarantees in exacerbating the overall liabilities position of the governments. It classified
guarantees into two categories i) 100 per cent default risk which are to be considered as debt
and ii) for the rest of guarantees, they can be assigned weights such as low, medium and high
with default risk e.g. 5 percent for Very Low risk, 25 percent for Low risk, 50 percent for
Medium risk and 75 percent for High risk. This idea was brought to execution in the study by
CRISIL Risk and Infrastructure Solutions Limited (2019) for the 15th Finance Commission
Report. Their study looked into the calculation of expected loss and unexpected loss assessment
to calculate the total loss on account of its guarantees to be added to the total debt for select
Indian states.
This study draws upon the methodology of RBI (2002) to analyse the fiscal risk and
vulnerability associated with contingent liabilities in the form of government guarantees in
Karnataka.

4
1.5 Objectives of the Study

The present study aims to analyse fiscal effects of government guarantees arising from the
financial obligations provided to PSUs from 2017-18 to 2022-23 as they are related to
Government of Karnataka. The specific objectives are as follows.

1. Analyse the policy objectives and trends in nature and composition of government
guarantees in Karnataka
2. Analyse the impact of default risk in government guarantees on fiscal policy in terms of
fiscal risk and vulnerability, especially since the outbreak of covid-19 in FY 2020-21 in
Karnataka
3. Draw policy implications on mitigating fiscal risks associated with government
guarantees as instruments of good fiscal management for GOK.

1.6 Methodology

1.6.1 Methods
 The trends in size, growth and composition of government guarantees are analysed with
the help of descriptive statistics such as percentages, ratios, growth rates, etc.
 The impact of default risk in government guarantees is computed by using methodology
adopted by CRISIL (2019). The amount outstanding categorised under various risk
weights. The analysis divides the risk into 5 types: very low risk (weight 0 percent), low
risk (weight 20 percent), medium risk (weight 60 percent), high risk (weight 80 percent)
and very high risk (weight 100 percent). In order to estimate the losses associated with
various entities, maximum probable loss, expected loss and unexpected losses are
calculated for each PSU. The implications of government guarantees on total liabilities
for the financial year 2020-21 is analysed by inclusion of expected and unexpected
losses arising from government guarantees as liabilities.
1.6.2 Data
The official secondary sources of information for this study include budget volumes and
Medium Term Fiscal Plans (MTFP) of the Government of Karnataka (GOK) and, published
documents of Reserve Bank of India (RBI), State finance accounts and audit reports of
Comptroller and Auditor General (CAG) of India.

5
1.6.3 Time period and Scope
The present study is based on the secondary sources of information. The reference time period
is from FY 2016-17 to 2020-21. The scope of this study is limited to government companies
and statutory corporations which are registered under India’s Companies Act. The special focus
is on emphasize the PSUs which have outstanding guarantees. The study does not include the
co-operative societies and other PSUs.

According to the Karnataka Ceiling on Government Guarantees Act, 1999, default risk is
defined as the probability of default by the company, institution or entity (borrower) on whose
behalf the state government was providing guarantee. This is calculated on the basis of the
amount borrowed, the type of industry and prevailing economic condition.

1.7 Details of Major Data Sources

1.7.1. Karnataka State Bureau of Public Enterprises (KSBPE)

GOK had set up Karnataka State Bureau of Public Enterprises (KSBPE) in July 1980. The main
functions of KSBPE were the preparation of Annual Report of Sate Level Public Enterprises
(SLPEs) for submission to the Legislature, co-ordinate conduct of management training
programs and develop MIS systems. The GOK had set up a Committee headed by Sri. P.
Padmanabhan, IAS for study of enhancement of performance of PSUs. The Padmanabhan
Committee recommended creation of a separate nodal agency cutting across all the departments
at the level of secretariat for this purpose.

In 2002, the KSBPE was converted in to a department and renamed as Department of Dis-
investment and Public Enterprise Reforms (DDPER), within Dept. of Personnel &
Administrative Reforms (DPAR). Main functions of DDPER were to minimize and resolve
problems with regard to disinvestments, amalgamation, structural re-organization, financial
management, closure, privatization of PSEs.

In 2005, the DDPER is converted into a full-fledged independent, separate department in

Secretariat and named as Department of Public Enterprises (DPE). DPE is one of the important
sources of data which involved in carrying out Evaluation studies of State Public Sector
Enterprises for assessing their performance, development and overall progress. In addition to
profit making the studies are aimed at healthy growth of the enterprises form time to time. Every
year evaluation of certain selected Public Sector Enterprises were being taken up by the DPE.

6
During 2022, The GOK has issued an order repealing the Department of Public Enterprises
(DPE) as part of an ongoing attempt to rationalise expenditure and shed administrative weight.
All matters that were handled by the DPE are given to the Finance Department, according to
recommendation of cabinet subcommittee.

1.7.2. CAG Audit Report on Public Sector Undertakings

This report deals with the results of audit of Government Companies and Statutory
Corporations. The accounts of the Government Companies (including companies deemed to be
Government companies as per the provisions of the Companies Act) are audited by the
Comptroller and Auditor General of India (CAG) under the provisions of Section 619 of the
Companies Act, 1956, and Sections 139 and 143 of the Companies Act, 2013. The report
comprised the data pertaining to financial support given by the government to the state PSUs
in the form of equity, guarantees, loans and grants/subsidy. The data on all the three types of
the audits were given in the report (Certificate audit, Compliance audit and performance audit).

1.7.3. State Budget Volume (Budget Memorandum)

The budget memorandum consists government guarantees given by the GOK in respect of long
term loans and share capital raised by the government companies, statutory organizations,
corporations and co-operative societies. As per the guarantees concerned, it has
data/information on name of the public body in whose favour guarantee is given, Financial
institution to whom the guarantee is given, rate of interest, maximum amount guaranteed
(Principle amount and Interest), guaranteed amount outstanding at the end of the financial year
and guarantee commission which includes guarantee receivable, received and balance
commission. As per the shares, debentures and bonds concerned, it has information on name of
the concern PSU, year of investment, type, no. of shares, face value of each share, amount
invested, percentage of government investment to the total paid up capital, dividend interest
received and credited to government during the year and dividend interest declared but not
credited to government account. Merits of the data available in budget volumes regarding
guarantees are as follows:
1. Each entity-wise data on the maximum amount guaranteed, the outstanding amount
guaranteed, and guarantee commission receivable, received, and balance amount.
2. Year-wise details on the loan availed, the name of financial institutions to whom the
government gave a guarantee, and the cost of loans are available.
3. Budget volumes are the authenticated source of information in GOK.

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1.8 Organization of the report

This report is organised into 5 chapters. Chapter 1 is introductory and it includes definition,
types and current status of the government guarantees in GOK. Chapter 2 highlighted the
policies related to government guarantees in India, Trends in size and composition of guarantees
are analysed in chapter 3. Chapter 4 studies the default risk in government guarantees and
chapter 5 includes major findings and policy implications.

8
 CHAPTER 2
GOVERNMENT POLICY ON GUARANTEES IN INDIA: AN OVERVIEW

2.1 Constitutional Provisions

State governments can extend guarantees to public bodies without the consent GOI.
Guaranteeing is an integral part of state borrowing as could be inferred from the provision under
Article 293(1) of the Constitution of India which is as follows:

(1) Article-293 borrowing by the States: Subject to the provisions of this Article, the
executive power of a state extends to borrowing within the territory of India upon the
security of the Consolidated Fund of the state within such limits if any as may from time
to time be fixed by the legislature of such state by law and to the giving of guarantees
within such limits, if as may be so fixed.
(2) The Government of India may, subject to such conditions as may be laid down by or
under any law made by parliament, make loans to any state or, so long as any limits
fixed under Article 292 are not exceeded, give guarantees in respect of loans raised by
any state and sums required for making such loans shall be charged on the Consolidated
Fund of India.
(3) A state may not without the consent of the government of India raise any loan if there
is still outstanding any part of a loan which has been made to the state by the government
of India or by its predecessor government, or in respect of which a guarantee has been
given by the government of India or by its predecessor government.
(4) A consent under clause (3) may be granted subjected to such conditions, if any, as the
government of India may think fit to impose. Considering these constitutional
interpretations, in the interest of the state government itself. There is a need for well-
defined rules and policies to govern guarantees (RBI, 1999).

2.2 Policy Structure 1950-1999

As early as April 1956, GOK laid down a rule that the rate of government guarantee commission
in respect of loans would be 1/3% p.a., when the loan amount is one lakh or below and 1% p.a.,
above one lakh. Co-operative societies and similar institutions were not brought under this
government order. In August 1958, aided industrial concerns and co-operative societies were
brought under this rule. Guarantee commission rates were fixed uniformly as ½% p.a., and ¼%
p. a respectively.

9
In February 1963, the Finance Department, GOK insisted the administrative departments to
disclose the unutilized guarantee amount, nature and extent of guarantee, rate of interest,
currency denomination, whether interest payment was also guaranteed etc.

Later in December 1966, GOK introduced slabs for guarantee commission rates as given in
Table 2.1.

Table 2.1: Guarantee commission slab rate, 1966 in Government of Karnataka

Sector < Rs. 10 lakhs < Rs. 50 lakhs >Rs.50
lakhs
Aided industrial concerns and small
½ % p.a. ¼ % p. a. 1/8 % p. a.
industries
Co-operative sugar factories, societies,
¼ % p. a. 1/8 % p. a. 1/16 p.a.
local bodies, etc.
Source: RBI, 2002.

In April 1968, the Finance Department of GOK issued precautions to be taken on government
guarantees.
a) Guarantees not availed to the extent sanctioned should be withdrawn or cancelled within
a year
b) The financial institutions should not raise any further loan without prior approval of the
state government.
c) Beneficiary’s accounts should be audited at least once a year by an approved auditor,
annual statement of accounts to be submitted to the Accountant General.

In September 1969, GOK revised the guarantee commission rate to 1% p.a., for all industrial
concerns, Small Scale Industries, and private persons and ½% p. a., for all bodies like co-
operative sugar factories, local bodies, etc.

In November 1971, Finance Department of GOK laid down the criteria and procedure on
government guarantees for administrative departments. The key suggestions were:

(i) The proposal should mention the public interest it will serve, credit worthiness of the
borrower, terms of borrowing, and other conditions if any.
(ii) A guarantee should become operative only after a mortgage deed for industrial units and a
personal bond for individuals.
(iii) Financing Institutions should promptly notify the government if there is any principal or
interest default.

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(iv) Guarantee deed should ensure non-provision of automatic debit from government facilities
for financial institutions. Bills should reach the treasury department only after duly
countersigned by the head of the concerned department.
(v) Administrative departments should review and send their guarantee position annually to
finance department not later than two months after the close of the year in a standard
proforma.

In October 1998, Finance Department, GOK instructed all administrative departments to

appoint the concerned internal financial advisor as nodal officer, or else principal secretary.
Secretaries will act as nodal officer. Also a penal interest of 15% would be levied on the
commission overdue.

In November 1998, Finance Department, GOK instituted departmental committees with

Principal Secretary of Finance, Principal Secretary of respective administration department,
chairman of public body to which guarantee is issued and a nominee from the lending
institution. The committee was to review the position regarding withdrawal of loan and its
utilization, once in three months.

2.3 Need for regulating government guarantees in India

The need for a guarantee policy was recognized at a meeting of Finance Secretaries in
November 1997. In response to the request made by the Finance Secretaries of the States, the
RBI constituted a Technical Committee on State Government Guarantees, consisting of
selected State Finance Secretaries to examine the growing magnitude of state government
guarantees and their potential impacts on the fiscal position of the state. The Committee
submitted its report in February 1999. The following were the recommendations by the
committee:

(i) Imposition of ceiling on guarantees

(ii) Selectivity in calling for and providing guarantees
(iii) Greater transparency in reporting of guarantees and standardization of documentation
(iv) Guarantee fee and constitution of a contingency fund for guarantees
(v) Monitoring and honouring of guarantees.

The changes and improvements that took place for effective management of guarantees by state
governments are given below.

11
2.4 The Karnataka Ceiling on Government Guarantee Act, 1999

The guidelines given in RBI’s report of the Technical Committee on guarantees, GOK, brought
out the Act, called Karnataka Ceiling on Government Guarantee Act in 1999. The objective of
this Act was to provide for limits on government guarantees issued on behalf of government
departments, public sector undertakings, local authorities, statutory boards and corporations
and co-operative institutions etc., for promoting fiscal discipline in the state. The salient features
of the Act are as follows.

1. The total outstanding guaranteed as on the first day of April of any year shall not exceed
eighty percent of the state’s revenue receipts of the second preceding year.
2. No government guarantees shall be given in respect of a loan of any private individual,
institution or company and shall be extended to the co-operative sector unless the share
capital contribution from the non –government sources is not less than the ten percent of
the total equity proposed.
3. The government shall charge a minimum of one percent as guarantee commission and can
enhance rate depending on the default risk of the project.
4. Performance guarantee (letter of comfort) may be given to all sectors but shall place
comprehensive report on liabilities before legislation within six months of the date of
giving performance guarantee.

The Act was amended in 2002 to provide that no guarantee commission shall be charged in
respect of guarantees extended during the period from 1.4.2001 to 31.3.2002 for loans granted
by the Karnataka State Co-operative Apex Bank Limited and Karnataka State Co-operative
Agriculture and Rural Land Development Bank Limited for the purpose of agriculture and in
turn to require them to reduce one percent interest in their lending rate in respect of the
agriculture loans disbursed by them during the mentioned period.

Ceiling on Guarantee- A comparative analysis

As per RBI Report of the Technical Committee on guarantees, few states like Karnataka and
Rajasthan (1999) Assam, Sikkim (2000), and West Bengal (2001) have introduced a policy for
ceiling on guarantees. A comparative development in different states relating to the imposition
of a ceiling on guarantees and guarantee commissions are described below.

12
Karnataka
The Karnataka Ceiling on Government Guarantees Act 1999, prohibits government to issue
guarantees on behalf of any private individual, institution or a company. It also prohibits
government to issue guarantees on behalf of Co-operative sector unless the share capital
contribution from the non-government sources is not less than 10 percent of total equity
proposed.

As per the above Act, total outstanding guarantees as on first day of April of any year should
not exceed 80 percent of GOK revenue receipts of second preceding year as in the books of
Accountant General of Karnataka. It also mandates the state government to charge a minimum
of 1 percent as guarantee commission which cannot be waived off under any circumstance. The
state government has to submit a report within 6 months of its failure to meet any contractual
obligation as stated under performance guarantees. As per Act 1999, performance guarantees
include letter of comfort, power purchase agreements, state support agreements, concession
agreements for infrastructure projects and other agreements guaranteed in certain performance
on behalf of government, PSUs, local authorities, statutory boards and Corporations and Co-
operative institutions.

Andhra Pradesh
The limit on guarantees that Andhra Pradesh government can issue on behalf of PSUs is
governed by the Andhra Pradesh Fiscal Responsibility and Budget Management Act, 2005.
This Act states that, the amount of annual incremental risk weighted guarantees to 90 percent
of Total Revenue Receipts (TRR) in the year preceding the current year. The guarantees are
classified into 5 categories and are assigned weights depending on the risk associated with the
guarantees. The different types of guarantees and the weights are Direct Liabilities (100%),
High Risk (75%), Medium Risk (50%), Low risk (25%) and very Low risk (5%) respectively.
The fixed guarantee fee as per the Act is in the range of 0.5 percent to 2 percent.

Telangana
The limit on the guarantees that Telangana government can issue on behalf of PSUs is governed
by the Fiscal Responsibility and Budget Management Act, 2005. This act states that, the amount
of annual incremental risk weighted guarantees to 90 percent of Total Revenue Receipts (TRR)
in the year preceding current year. Telangana and Andhra Pradesh adopted similar criterion to
classify the guarantees and risk weights depending on the risk associated with the guarantees.

13
Tamil Nadu
The limit on the guarantees that the Tamil Nadu government can issue on behalf of PSUs is
governed by the Tamil Nadu Fiscal Responsibility and Budget Management Act, 2003. This
Act limits total outstanding guarantees to 100 percent of the total revenue receipts in the
preceding year or at 10 percent of GSDP whichever is lower. It limits the risk weighted
guarantees to 75 percent of the total revenue receipts in the preceding year or 7.5 percent of
GSDP.

Gujarat
The limit on the guarantees that the Gujarat government can issue on behalf of PSUs,
Corporations and Cooperative Institutions is governed by the Gujarat Fiscal Responsibility Act,
2005 and Gujarat Guarantees Act, 1963 which provides cap on the total guarantees. The Gujarat
Guarantees Act, 1963 limits the Gujarat government to total outstanding guarantees of Rs
20,000 cr. Guarantee fee of 1 percent is mandated.

West Bengal

The limit on the guarantees is governed by the West Bengal Fiscal Responsibility and Budget
Management Act, 2010 and West Bengal Ceiling on Government Guarantees Act, 2001. As per
the Act, the total outstanding government guarantees on first day of April of any year should
not exceed 90 percent of the state revenue receipts of the second preceding year. A guarantee
fee of 1 percent is mandated which rises with greater default perception of the project.

Kerala
The limit on the guarantees is governed by the Kerala Fiscal Responsibility Act, 2003 and
Kerala Ceiling on Government Guarantees Act, 2003. As per the Kerala Ceiling on Government
Guarantees Act, 2003, the total outstanding government guarantees on first day of April of any
year should not exceed Rs 14,000 crores. This Act prohibits the government to issue guarantees
in respect of a loan of any private individual, institution or a company. A fee of minimum 0.75
percent per annum is mandated as guarantee commission and which cannot be waived under
any circumstance.

Punjab
The limit on the guarantees is governed by the Punjab Fiscal Responsibility and Budget
Management Act, 2003. The Punjab Fiscal Responsibility and Guarantees Act, 2003 puts limits
on the total outstanding government guarantees on long term debt to 80 percent of the revenue

14
receipts of previous year. Guarantees on short term debt are to be given only for working capital
or food credit in either case it must be backed by physical stocks. A fee of 2 percent for term
loans and 1/8 percent for procurement agencies is collected as guarantee commission.

2.5 RBI Report to assess the Fiscal Risk of State Government Guarantees- July 2002

In Eighth Conference of the Finance Secretaries of State Government with the Reserve Bank
of India (RBI), on May 26, 2001, the issues of differences in guarantees and their fiscal impacts
were discussed. The members felt the need to arrive at a methodology to assess the fiscal risk
associated with each guarantee and to review the legislation and acts. It was decided to
constitute a group to examine the fiscal risk of guarantees extended by state governments. The
committee submitted its report in July 2002 and its key recommendations were as follows.

1. Guarantees regarding liabilities that were intended to be met out of budgetary resources
should be treated as equivalent to debt
2. A tracking unit for guarantees may be designated
3. All financial institutions should examine the commercial viability of projects with due
diligence irrespective of government guarantee. Where a guarantee is taken as credit
enhancement, it should be reflected in reduction of lending rate.
4. Project risk and credit rating can be used to assess the fiscal risk of the guarantees.
5. Government can transfer one percent of outstanding guarantees to the Guarantee
Redemption Fund (GRF).
6. The total of such likely development during the life of guarantees could then be treated as
normal debt and clubbed together with debt obligations.

2.6 Recent Developments

In August 2003, the Finance Department of GOK circulated the aspects to be reviewed while
recommending cases for government guarantees.
1. Public interest which the guarantee will serve
2. Credit worthiness of borrower and risk involved by giving guarantee
3. Total cost and financial viability of project
4. Terms of guarantee (period, rate of interest, repayment etc.,
5. Detailed project proposal with projected cash flow statements, past 3 to 5 years’ balance
sheet, profit/loss statement, last 5 years accumulation net worth.
6. Key financial ratios like debt service coverage ratio and quick ratio.
7. Project evaluation and risk analysis statement by the financial institution.

15
In May 2006, the Department of Small Savings and State Lottery in Financial Department has
been redesigned as the “Department of Investment Tracking and Realisation, Small Savings
and State Lottery”. This department's responsibility includes pursuing recovery of guarantee
commission on loans borrowed on the state government guarantee by the companies and
corporations and shall collect and maintain the statistics and documents regarding investments
and guarantees of the state, systematically track the revenue in the form of interest, dividend,
commission, etc.

In 2015-15, as per the recommendations of the RBI’s Technical Committee on Guarantees, the
GOK discloses the guaranteed figures in a separate budget document, i.e., the Budget
Memorandum, which publishes the details of guarantees, shares, and securities regularly in the
annual budget.

In 1992, the Central Government decided the fee structure for guarantees. Borrowings under
the market borrowing programme were to be charged a guarantee fee of 0.25 percent per annum
of the guaranteed amount whereas for guarantees covering public sector borrowings, a
guarantee fee of 1 percent was fixed. For other borrowings, the guarantee fee was fixed at 2
percent.

As per the guidelines given in RBI’s report of the Technical Committee on guarantees, state
governments have made changes and improvements in their existing policy structure for
effective management of guarantees. On the recommendations of this Technical Committee,
the state governments have taken initial steps towards the imposition of a cap on guarantees for
promoting fiscal discipline in the state. The objectives of the acts were varied across the states.

As per ceiling limits, the structure of guarantee fee varies from state to state. It ranges from 0.1
percent to 2 percent of the guaranteed amount in different Indian states.

Karnataka Ceiling on Government Guarantees Act 1999 is different from other states ceiling
acts in following ways 1). Prohibits government to issue guarantees on behalf of any private
individual, institution or a company. 2). Prohibits government to issue guarantees on behalf of
Co-operative sector unless the share capital contribution from the non-government sources is
not less than 10 percent of total equity proposed. 3) Mandates, state government to charge a
minimum of 1 percent as guarantee commission which cannot be waived off under any
circumstance. 4) No mandate for categorising guarantees into different types based on risk
weights, as in the states of Andhra Pradesh and Telangana.

16
 CHAPTER 3
TRENDS IN SIZE AND COMPOSITION OF GOVERNMENT GUARANTEES IN
KARNATAKA

3.1 Size of government guarantees and liabilities

The chapter describes the trend of government guarantees over the period of time, the size of
the guarantees and the sector-wise distribution of guarantees by GOK.

Table-3.1: GOK’s guarantees in national context: 2016-17 to 2021-22

Total outstanding
Total Outstanding GG Total Liabilities guarantees as a
(₹ in Crores) (₹ in Crores) percentage of total
Year
liabilities
All India Karnataka All India Karnataka India Karnataka
2016-17 311528 15,392 38,09,357 2,11,169 8.18 7.29
2017-18 429688 18,415 42,92,495 2,45,951 10.01 7.49
2018-19 537801 24,091 47,86,770 2,86,329 11.24 8.41
2019-20 593982 26,830 53,50,716 3,38,666 11.10 7.92
2020-21 (RE) 448472 32,732 61,49,126 4,01,227 7.29 8.16
2021-22 (BE) 203486 33,149 69,47,045 4,61,833 2.93 7.18
Source: RBI, 2021.
At national level, the total outstanding guarantee was Rs. 3,11,528 crore in FY 2016-17 and
increased to Rs. 5,93,982 crore in 2019-20. Further, it declined to Rs. 2,03,486 crore in FY
2021-22 (BE) (Table-3.1).

The total outstanding guarantees as a percentage of total liabilities at all India level was higher
in year 2018-19 (11.24%) followed by 2019-20 (11.10%), which was not consistent across the
years, but had fluctuations all over the years. During FY 2021-22 (BE), the total outstanding
guarantees as a percentage of total liabilities was 2.93 percent due to more or less 50 percent
reduction in total outstanding government guarantees in FY 2021-22 (BE). The reduction in
outstanding government guarantees is due to the repayment of the guaranteed amount by the
states like Telangana, Andhra Pradesh, and Tamil Nadu. Out of all the states, these three states
accounted for about 64 percent of the outstanding guarantees during 2020–21 (RE), which they
cleared during 2021–22 (BE). Hence, the total outstanding guarantees were reduced by about
50 percent. (RBI, 2021).

Total outstanding government guarantees in Karnataka was Rs. 15,392 crores during the FY
2016-17 and raised to Rs. 33,149 crores in FY 2021-22(BE) (Table-3.1). On an average, total
outstanding guarantees as a percentage of total liabilities was in the range between 7 to 8.5

17
percent. As compared to the national level, the share of government guarantees to total liabilities
in state was higher during the FY 2021-22 due to the prevalence of pandemic lockdown and
also restrictions on functioning of entities has led lower repayment of the guaranteed amount
including principal, interest and guarantee commission.

The total outstanding guarantee in India was around 2 percent of the GDP in FY 2016-17 and
increased to 2.9 percent in FY 2019-20 (Fig-1). The outstanding guarantees of states witnessed
a declining trend in the post FRBM period, plummeting from 5.4 per cent of GDP at end-March
2006 to 2.0 per cent of GDP at end-March 2017. The decline in guarantees is primarily driven
by the guarantees to power sector being subsumed in state government liabilities under Ujwal
DISCOM Assurance Yojana (UDAY). After the implementation of UDAY, states reduced their
outstanding guarantees to 2 percent of GDP in 2016-17, due to improvement in financial health
of power sector entities (RBI, State Finances, 2021).

However, in 2017–18, the guarantees witnessed a significant jump to 2.5 percent of GDP and
reached to 2.9 percent of GDP in end-March 2020 indicating early signs of fiscal risks. The
gradual upward movement was due to farm loan waivers, growth slowdown in 2019-20 and
pandemic-related revenue losses and additional expenditures increased in 2020-21 (RBI, 2022).

Fig-1: Size and share of Government Guarantees at all India level: 2010-11 to 2021-22

700,000 4
3.5
Rs. in crore

600,000
500,000 3
400,000 2.5
2
300,000 1.5
200,000 1
100,000 0.5
0 0

Total Outstanding % of GDP

Source: RBI, Database (Various years).

The share of government guarantees to the Gross State Domestic Product (GSDP) in Karnataka
was 1.61 percent during FY 2010-11 and increased to 1.97 percent during FY 2020-21 (Fig-2).

18
Fig-2: Size and share of Government guarantees to in Karnataka: 2010-11 to 2020-21

35,000 2.50
30,000
2.00
25,000
20,000 1.50
Rs in crore

15,000 1.00
10,000
0.50
5,000
0 0.00
2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21

Total outstanding guarantees % GSDP

Source: RBI, State Finances: A Study of Budgets (Various Years)

Karnataka's outstanding guarantees as a proportion of liabilities were 6.53 percent, much lower
than Telangana (36.10%), Rajastan (18.97%), Andhra Pradesh (17.79%), Uttar Pradesh
(16.51%) and Madhya Pradesh (15%). In comparison to Karnataka, several state governments
offered smaller guarantees, such as, Gujarat, Himachal Pradesh, Bihar, Odisha, and
Maharashtra (Figure 3).

Fig-3: Average. Outstanding guarantees - As percentage of Average liabilities for major

states (2016-17 to 2021-22)

36.10
Percentage

18.97 17.79
16.51 15.00
11.89 10.99
8.76 8.48 7.44 6.53 6.45
5.50 5.27
3.00 1.37

Source: RBI, Database (Various years).

3.2 Growth of guarantees in Karnataka

Outstanding amount of guarantees in the state from 2010–11 to 2021–22 was collected from
CAG reports, RBI state finance reports and various issues of the state budget memorandum. To
examine the growth rates of the outstanding guarantees over the years, the annual growth rate
and compound annual growth rate were calculated and the results are given in the Table 3.2.

19
On an average, the total outstanding government guarantee in the state has grown at the rate of
16.42 percent per year (Average Annual Growth Rate AAGR) and its Compound Annual
Growth Rate (CAGR) remained at 15.78 percent from 2010-11 to 2021-22.

Table-3.2: Growth of government guarantees in Karnataka: 2010-11 to 2021-22

The amount outstanding as on 31st March

Total outstanding Principal AGR Interest AGR
Year AGR
amount (Rs. (Rs. (%) (Rs. (%)
(%)
Crore) Crore) Crore)
2010-11 6,617 6,448 169
2011-12 6,640 0.35 6,491 0.67 149 -11.83
2012-13 6,688 0.72 6,565 1.14 123 -17.45
2013-14 7,783 16.37 7,671 16.85 112 -8.94
2014-15 11,033 41.76 10,890 41.96 143 27.68
2015-16 13,325 20.77 13,155 20.80 170 18.88
2016-17 15,392 15.51 15,227 15.75 165 -2.94
2017-18 18,415 19.64 18,266 19.96 149 -9.70
2018-19 24,091 30.82 23,913 30.92 178 19.46
2019-20 26,830 11.37 26,679 11.57 151 -15.17
2020-21 32,732 22.00 32,506 21.84 226 49.67
2021-22 33,149 1.27 33,023 1.59 126 -44.13
AAGR (%) 16.42 16.64 0.50
CAGR (%) 15.78 16.01 -2.62
Source: CAG, Finance Accounts (Various Years), RBI, State Finance: A Study of Budgets (Various
Years) (Note: AAGR: Average Annual Growth Rate, CAGR: Compound Annual Growth Rate, AGR:
Annual Growth Rate).

The annual growth rates of total outstanding guarantees of both principal and interest shows a
similar trend. During the year 2014-15 a sharp increase was witnessed due to 41 percent hike
in the principal amount outstanding. The trend of annual growth rate had highly fluctuated over
the years, as shown in Fig-4).

Figure 4: Annual Average Growth rate of Government Guarantees in Karnataka

50.0

30.0
Percentage

10.0

-10.0 2011- 2012- 2013- 2014- 2015- 2016- 2017- 2018- 2019- 2020- 2021-
12 13 14 15 16 17 18 19 20 21 22
-30.0
Total Outstanding Principal Interest
-50.0

20
3.3 Composition of Government guarantees in Karnataka

PSUs in the state operating under various departments, viz., Co-operation, Urban Development,
Housing, Finance, Energy, Water Resource, Public Works, and others included Home and
Transport, Minorities Welfare, Social Welfare, Backward class welfare, Department of Women
and Child Development, Public works, Food and Civil Supplies and Animal husbandry.
Department-wise share of total outstanding guarantees is presented in Table 3.3.
Table-3.3: Sectoral Distribution of Government Guarantees in Karnataka (as on March
2021)
SN Total outstanding Share of outstanding
Type of the PSUs
guarantees (Rs. Lakh) guarantees (%)
1. Co-operation Department 127570.86 3.90
2. Urban Development Department 95516.92 2.92
3. Housing Department 151513.99 4.63
4. Finance Department 125129.16 3.82
5. Energy Department 1091258.93 33.34
6. Water Resource Department 1606123.44 49.07
7. Public works 42680.10 1.30
8. Others 33469.17 1.02
9. Total 3273262.57 100.00
Source: Budget Memorandum, 2022-23, GOK.

Table 3.3 shows that guarantees to the Water Resource Department constituted a major share
of total outstanding guarantees (49.07%) and followed by Energy Sector (33.34%), Housing
Department (4.63%), Co-operation Department (3.90%), Finance Department (3.82%), Urban
Development Department (2.92%), Public works (1.30%) and other sectors including
Commerce and industries (0.36%), Agriculture department (0.05%), Minorities welfare
department (0.08%), Social welfare department (0.03%), Backward class welfare department
(0.21%) and Food, Civil Supplies and consumers redressal (0.31%).

The total outstanding guarantee as a percentage of total liabilities in India was 2.9 percent in
the fiscal year 2019–20 as a result of improvement in financial health of power sector PSUs.
The amount of outstanding government guarantees in Karnataka is increased by 54 percent
during 2016–17 to 2021–22. The outstanding guarantees of Karnataka was 6.53 percent of total
liabilities, which is significantly less than the outstanding guarantees for the states of Telangana,
Rajasthan, and Andhra Pradesh. At the same time, the growth rate of state government
guarantees to financial institutions on behalf of PSUs is also an added element to the severity.
The total outstanding guarantees in Karnataka has grown at the rate of 16.42 percent per annum
and its compound annual growth rate was 15.78 percent over the years of ten years. The

21
distribution of the guarantees among the different sectors, Water Resource Department
constituted the major share in Karnataka. This department included four major nigam’s like
Karnataka Neeravari Nigam, Krishna Bhagya Jala Nigam Ltd, Cauvery Neeravari Nigam Ltd
and Visvesharaya Jala Nigam Ltd. Thus, it is essential for GOK to ensure that the companies
and entities financial stability in repaying the availed loans which are associated with the
guarantees. The default risk associated with these guarantees are analysed in next chapter
(chapter-4).

22
 CHAPTER 4
DEFAULT RISK IN GOVERNMENT GUARANTEES

4.1 Objectives of the chapter

Every loan is associated with many kinds of risk and a degree of uncertainty associated with its
future profitability. Total uncertainty is not a simple summation of the individual risk, rather
they are correlated among themselves. There is a need to identify and systematically assess the
risk involved in each loan issued through guarantees. However, no such framework has been
followed in Karnataka, though guidelines have been put forth by GOK. This chapter fills in this
policy gap by developing a framework for risk adjusted contingent liabilities with reference to
government guarantees in Karnataka.

4.2 Risk assessment: International perspectives

Lenders should analyze the creditworthiness of the borrower, and the net positive value of a
project before sanctioning any loan. Guaranteed loans should follow the same steps as non-
guaranteed loans. In many cases, lenders do not follow the rigid procedures when it is
guaranteed by a government. Therefore it becomes part of the government’s responsibility to
investigate the beneficiary’s creditworthiness.

According to Brixi and Mody (2002), the institutional framework for dealing with fiscal risks
is mainly related to rules and practices of information disclosure, monitoring, fiscal planning,
and budgeting. The institutional framework affects the government’s incentives and ability to
constrain, control and manage its fiscal risks. The framework must be such that it promotes a
risk-awareness culture in government and minimize the scope of fiscal opportunism. It is
necessary to identify and assess the risk involved in government guarantees and to estimate the
cost of the guarantee and to have a set of guidelines to follow before approving any guarantee.

The Financial Services Authority (FSA) is a risk-based regulator in London and uses a
framework called ARROW (Advanced Risk Responsive Operating Framework) to risk-based
regulation operational. This framework was recognized in the Financial Service and Market
Act 2000 in the UK.

The four steps involved in the risk assessment framework are

1. Risk Identification
2. Risk Measurement
3. Risk Mitigation

23
 4. Risk Monitoring and Reporting

The United States encountered a similar situation in early 1990, with loan guarantees and biases
created in a simple cash-based system. Under the Federal Credit Reform Act of 1990, each of
these forms of credit was valued using a financially equivalent metric- the expected present
value of future costs. The budgetary cost of credit is defined as the present value discounted at
treasury interest rates of comparable maturity of the expected cash outflows from the
government minus the expected cash inflows to the government.

4.3 Framework for fiscal risk analysis of government guarantees in Karnataka

We analyse the cost of guarantees by using interest rates of the loans, assessment of default risk
through guarantee commission, and find out the maximum probable loss, expected loss and
unexpected loss associated with PSUs and their share in total liabilities of the state. Further,
impact of default on total liability of the state government is calculated.

4.4 Cost of guarantees by assessment of rate of interest and size of borrowing

To calculate the cost of guarantees through interest rates, the interest rates at which PSUs
obtained loans are classified by different interest rates. As per data available in the budget
memorandum 2022–2023, there are 32 PUSs, excluding co-operative societies and banks that
have outstanding guarantees. The lower interest rate at which PUSs avails loans is 2 percent per
annum, and the highest interest rate is around 15 percent per annum. These ranges are the
average interest rates.

It can be seen from Table 4.1 that, at various interest rates, 8.3 percent per annum was the rate
at which a higher maximum amount was guaranteed (Rs. 15,79,481 lakh) and the higher total
outstanding amount as recorded (Rs.12,09,170 lakh). Out of the total amount, the highest
percentage share was observed at 8.3 percent interest rate, at which 38.46 percent of the amount
availed was outstanding. The minimum interest rate was 2 percent per annum and at which,
only the non-commercial entities availed loans from various corporations viz., NMDFC,
NHFDC, NBCFDC, NSTFDC, and NSCFDC. The maximum interest rate was 14.75 percent
per annum at which Karnataka Handloom Development Corporation availed a loan of Rs. 2,400
lakh during 2021 from the State Bank of India and a consortium bank.1

1 A consortium bank is a bank created by numerous banks to fund a project that is too large for one bank
to do alone.
24
Table 4.1: Cost of government guarantees by interest rate at the end of March 2021:
Karnataka
(Rs. In Lakh)
% to
Maximum Principal Total % to Total
Interest Interest Maximum
amount amount (Principal + outstanding
Rate (%) outstanding amount
guaranteed2 outstanding Interest) amount
guaranteed
2 35391.58 5518.74 0 5518.74 0.83 0.18
2.25 5990.00 2499.09 0 2499.09 0.14 0.08
3 15257.00 1881.60 154.05 2035.65 0.36 0.06
7 275500.00 195122.40 0 195122.40 6.45 6.21
7.25 40000.00 10000.00 0 10000.00 0.94 0.32
8.1 281054.00 272263.50 5693.65 277957.10 6.58 8.84
8.15 224088.00 198373.00 0 198373.00 5.24 6.31
8.25 600500.00 372327.00 0 372327.00 14.05 11.84
8.3 1579481.00 1209170.00 0 1209170.00 36.97 38.46
8.55 298500.00 278500.00 0 278500.00 6.99 8.86
8.85 497298.60 242526.90 2363.15 244890.00 11.64 7.79
8.96 17500.00 5500.00 255.99 5755.99.00 0.41 0.18
9 304116.80 281427.20 777.27 282204.50 7.12 8.98
9.22 77120.00 42593.66 86.44 42680.10 1.81 1.36
9.9 7339.00 2044.02 1678.82 3722.84 0.17 0.12
12 11000.00 11000.00 0 11000.00 0.26 0.35
14.75 2400.00 2400.00 0 2400.00 0.06 0.08
Grand
4272536 3133147 11009.37 3144156 100.00 100.00
Total
Source: Budget Memorandum, 2022-23, GOK.

Details of the guarantee commission associated with the rate of interest are given in Table 4.2.
Out of the total guarantee commission receivable, the highest portion of the commission is
associated with 8.3 percent interest rate (42.70%) followed by an 8.85 percent interest rate
(12.90%). Further, out of the total guarantee commission received, 52.31 percent was collected
from the loan associated with 8.3 percent of the interest rate followed by 8.85 percent. Out of
the total receivable commission, 63.40 percent was repaid during 2020-21. Among 32 PSUs, 9
PSUs repaid the entire guarantee commission without any balance, and 6 PSUs repaid more
than 50 percent of the guarantee commission during the financial year. Four PSUs repaid less
the 50 percent of the commission, 9 PSUs does not repay any of the guarantee commission
during the financial year, and the rest of the 3 PSUs were not associated with any guarantee

2 It is the minimum limit fixed by the Finance Department (Administration) based on the entity's asset
position, previous turnover, repayment capacity, creditworthiness, etc.

25
commission. The guarantee commission associated with Karnataka Khadi & Village Industries
Board is exempted because the entity availed the loan before the implantation of the Karnataka
Ceiling on Government Guarantee Act 1999. It can be observed from the Table 4.2 that, at 9.22
percent of the interest rate, the received amount was higher than the receivable amount.
Karnataka Road Development Corporation Limited repaid the extra commission during the
financial year 2021.

Table 4.2: Size of guarantee commission by interest rate by the end of March 2021
(Rs. In Lakh)
GC % to TGC % to TGC Ratio of GC
Interest rate (%) GC R’cvd4
R'ble 3 R'ble R’cvd R’vd to R’ble
Loan not Availed 1216.9 119.05 3.05 0.47 9.8
2 196.26 84.49 0.5 0.33 43.1
2.25 69.01 0 0.2 0.00 0.0
2.75 17.37 0 0.0 0.00 0.0
3 61.99 47.74 0.2 0.19 77.0
7 1999.29 1999.29 5.0 7.91 100.0
7.25 2267.34 0 5.7 0.00 0.0
8.1 943.50 943.5 2.4 3.73 100.0
8.15 904.85 904.85 2.3 3.58 100.0
8.25 3501.93 3501.93 8.8 13.85 100.0
8.3 17021.71 13229.45 42.7 52.31 77.7
8.55 2767.00 2767 6.9 10.94 100.0
8.85 5142.24 849 12.9 3.36 16.5
8.96 1198.67 0 3.0 0.00 0.0
9 918.85 129.95 2.3 0.51 14.1
9.22 478.57 617 1.2 2.44 128.9
9.8 1096.91 22.98 2.7 0.09 2.1
12 55.00 55 0.1 0.22 100.0
14.75 39.91 17.79 0.1 0.07 44.6
Grand Total 39897.30 25289.02 100.0 100.00 63.4
Source: Budget Memorandum, 2022-23, GOK.
Notes: GC: Guarantee commission, GC R'ble: Guarantee Commission Receivable, GC R’cvd:
Guarantee commission received, TGC: Total Guarantee Commission. Loan not availed: where
outstanding amount is zero but GC is outstanding.

3 Guarantee Commission Receivable: Amount of the commission that needs to be paid by the entity as
against the loan amount.
4 Guarantee Commission Received: It is the amount that is actually paid by the entity during the
particular financial year.
26
Table 4.3: Size of guarantee commission by PSUs in Karnataka (end of March 2021)
(Rs. Lakh)
Maximum Principal
Interest Name of the Interest GC GC
amount amount Total
Rate (%) PSUs outstanding R’ble R’vd
guaranteed outstanding
Karnataka State
Financial
8.3 190800 125129.2 0 125129.2 1450.46 1450.46
Corporation
(KSFC)
Krishna
Bhagya Jala
8.3 1012000 760174 0 760174 12087.26 8295
Nigam Limited
(KBJNL)
Power
Company of
8.3 376681 323866.6 0 323866.6 3483.99 3483.99
Karnataka Ltd.
(PKCL)
Total 1579481 1209170 0 1209170 17021.71 13229.45
% its corresponding total 36.97 38.59 0.00 38.46 42.66 52.31
Source: Budget Memorandum, 2022-23, GOK.
Note: GC R'ble: Guarantee Commission Receivable, GC R’cvd: Guarantee commission received.

It can be seen from Table 4.3 that, Karnataka State Financial Corporation (KSFC), Krishna
Bhagya Jala Nigam Limited (KBJNL), and Power Company of Karnataka (PCK) are the three
PSUs with highest maximum amount guaranteed and the highest amount outstanding as of
March 31, 2021. These three PSUs accounted for 38.46 percent of total amount outstanding.
Out of total guarantee commission receivable, 42.66 percent of the commission was associated
with the mentioned PSUs, and of the total received commission, 52.31 percent was received
from these three PSUs during the year. These are three entities that received the majority of the
loan through guarantees; if they become defaults, the government's liabilities will increase by
38.46 percent. Among 3 PSUs, KSFC and PCK repaid the entire amount of guarantee
commission during the financial year 2021, and a lesser portion of the commission is left with
KBJNL.

27
 4.5 Calculation of default risk and probable losses

Using the methodology adopted by the CRISIL (2019) study, we analysed the classification of
guarantees of GOK. The CRISIL (2019) study uses many risk and trigger factors while placing
the commercial entities, corporations, boards, etc. into various risk categories based on the
product or service provided, customer base, whether the entity generates enough resources to
meet the loan repayments, etc. Data from Finance Accounts of CAG for GOK are used of this
purpose and the principal and interest amount outstanding in a financial year is considered.
Table 4.4 provides the details of amount outstanding, categorized under various risk weights.
The analysis divides the risk into very low (with 0% risk weight), low (20%), medium (60%)
and high (80%) and very high (100%).

Table 4.4: Risk category of government guarantees in Karnataka

₹.Crore
Category Risk 2016-17 2017-18 2018-19 2019-20 2020-21
weight P I P I P I P I P I
Very Low 0 1 0 0 0 0 0 0 0 0 0
Low 20 1662 0 1599 0 1505 0 1395 0 4600 0
Medium 60 551 1 553 0 591 4 534 0 5234 1
High 80 10773 155 13529 124 18330 146 22282 162 22617 223
Very high 100 167 0 140 0 128 0 115 3 55 3
Total 13154 156 15821 124 20554 150 24326 165 32506 226
Source: Calculated by author using CRISIL risk categories and Risk weights.
Note: P: Principal amount, I: Interest amount.

It can be observed from Table 4.4 that, a majority of the guarantee outstanding principal
amount and interest is concentrated towards the high category with a risk weight of 80 per
cent. In the year 2016-17, nearly 82 per cent of the total principal amount outstanding on
account of guarantees and nearly 99 per cent of interest was in the high risk category. For the
years 2017-18, 2018-19, 2019-20 and 2020-21, the guarantees under high risk were 86, 89, 92
and 70 per cent respectively of the total guarantees outstanding for those years. Thus there has
been a consistent rise in the amount outstanding under the high risk category during the period
2016-17 to 2020-21, apart from an absolute rise in outstanding guarantees of GOK. On the
one hand, it is seen that the total outstanding guarantees in absolute terms have increased
substantially, from Rs. 13,310 crore in 2016-17 to Rs. 32,732 crore in 2020-21.

28
The 15th Finance Commission has recommended that the government guarantees must be
included in the broader definition of public debt and also provide budgetary provisions. The
analysis furthers the study on guarantees by calculating the probable losses from the
outstanding principal and interest amount of guarantees and adding it to the total liabilities.
Adding the entire amount of outstanding amount does not seem reasonable and only the losses
based on the risk weight should be added to the total liabilities of the GOK. In order to estimate
the losses, the methodology developed by CRISIL (2019) is applied and three types of losses
are calculated:

1. Maximum probable loss

Annual Maximum Probable Loss = (Annual Repayment + Interest) (1)

Annual Repayment is the outstanding principal amount at the beginning of the FY.

2. Expected loss

Expected Loss = (Annual Repayment + Interest) * Risk Weight (calculated separately for each
risk category) (2)

Expected loss is annual maximum probable loss multiplied by risk weight developed by
CRISIL for each guarantee. Higher the risk weight, greater is expected loss associated with
guarantee.

3. Unexpected loss

Unexpected Loss = Annual Probable Loss – Expected Loss (3)

The analysis presented in this report is different from the analysis in CRISIL (2019) on two
counts. One is the present study considered the annual repayment as total of principal and
interest amount outstanding in a financial year. And it does not considered the usual time
period of the loan repayment, because the loans associated with the entities are not uniform.
Two, CRISIL (2019) calculated the losses for all types of PSUs. Whereas this report
considered only statutory organisations and government companies for calculating the losses.

29
Table 4.5: Calculation of losses associated with government guarantees in Karnataka as on March, 2021
(₹. Crore)
Maximum Risk
Expected Unexpec
S probable loss Weights
PSUs Principal Interest Total Loss ted loss
N in crore (P+I) CRISIL
7=(5*6) 8=(5-7)
5=4 (%)
1 2 3 4 5 6 7 8
A Statutory Organisation
1 KSFC 1251.29 0.00 1251.29 1251.29 0.20 250.25 1001.03
2 HESCOM 2800.62 0.00 2800.62 2800.62 0.60 1680.37 1120.25
3 GESCOM 1730.51 0.00 1730.51 1730.51 0.80 1384.41 346.10
4 BESCOM 1983.73 0.00 1983.73 1983.73 0.60 1190.23 793.49
5 CESCOM 992.12 56.94 1049.06 1049.06 0.80 839.24 209.81
6 Karnataka Khadi and Villages Industries Board 20.44 16.79 37.23 37.23 0.80 29.78 7.45
7 KUWSSB 933.76 0.00 933.76 933.76 0.70 653.63 280.13
8 BWSSB 13.64 7.77 21.41 21.41 0.80 17.12 4.28
TOTAL 9726.12 81.50 9807.61 9807.61 6045.06 3762.54
B Government Companies
9 Karnataka Handicrafts Development Corporation 0.01 0.00 0.01 0.01 0.80 0.011 0.00
10 Mysore Paper Mills 55.00 2.56 57.56 57.56 1.00 57.56 0.00
11 PCKL 3238.67 0.00 3238.67 3238.67 0.20 647.73 2590.93
12 KPC 110.00 0.00 110.00 110.00 0.20 22.00 88.00
13 KHDC 24.00 0.00 24.00 24.00 0.60 14.40 9.60
14 D.Devaraj Urs B.C.D.C 55.19 0.00 55.19 55.19 0.80 44.15 11.04
15 Karnataka Minorities Development Corporation 24.99 0.00 24.99 24.99 0.80 19.99 5.00
Karnataka Vishwakarma Communities
16 10.81 1.25 12.06
Development Corporation 12.06 0.80 9.64 2.41
17 KNNL 3723.27 0.00 3723.27 3723.27 0.80 2978.61 744.65
18 KRDC 425.94 0.86 426.80 426.80 0.60 256.08 170.72

30
 19 KBJNL 7601.74 0.00 7601.74 7601.74 0.80 6081.39 1520.35
20 CNNL 2785.00 0.00 2785.00 2785.00 0.80 2228.00 557.00
21 VJNL 1951.22 0.00 1951.22 1951.22 0.80 1560.97 390.24
Rajeev Gandhi Housing Development
22 Corporation 1491.51 23.63 1515.14 1515.14 0.80 1212.11 303.03
Karnataka Maharshi Valmiki Scheduled Tribes
23 Development Corporation 8.01 0.29 8.30 8.30 0.80 6.63 1.66
24 Karnataka State Seeds Corporation 0.00 0.18 0.18 0.18 0.80 0.14 0.04
Total 21505.35 28.78 21534.13 21534.1 15139.50 6394.67
Total (A+B) 31231.47 110.28 31341.74 31341.74 21184.52 10157.22
Source: Author calculation
Table 4.5 presents the losses on account of guarantees for GOK based on the risk weights, total principal amount and interest outstanding at the
beginning of financial year (using eqs.1-3). The results presents (a) total probable losses for the year 2020-21, (b) estimates expected and (c.)
measures the unexpected losses for GOK across various risk categories based on Table 4.4. Expected losses are the losses the GOK needs to take
into consideration as they are most likely to occur. The total expected losses were Rs. 21,184.52 crore. This has been due to the accumulation of
guarantees under the high risk category.The expected losses from the high risk category comprised about 68 percent of total maximum probable
loss,. Thus, both in absolute terms (in Rs. crore) as well as in relative terms (percentage share of total expected losses), high risk guarantees have
been rising between 2016-17 and 2020-21 (Table 4.4).

Among the statutory organisation, HESCOM (Hubli Electricity Supply Company Ltd.) shows maximum percentage (27.80%) of total expected
loss followed by GESCOM (Gulberga Electricity Supply Company Ltd) (22.90%), BESCOM (Bangalore Electricity Supply Company Ltd.)
(19.69%), CESCOM (Chamundeshwari Electricity Supply Company Ltd.) (13.88%) and KUWSSB (Karnataka Urban Water Supply and Sewerage
Board (10.81%). Among the government companies, around 40 percent of total expected loss was associated with Krishna Bhagya Jala Nigam
Ltd., followed by Karnataka Neeravari Nigam Ltd. (19.67%), Cauvery Neeravari Nigam Ltd.(14.72%) and Visvesvaraya Jala Nigam Ltd.
(10.31%).

31
4.6 Impact of government guarantees on total liabilities in GOK

The 15th Finance Commission suggested for the inclusion of government guarantees to the total
liabilities of the state governments. Figure 5 presents the increase in total liabilities for GOK
during 2020-21 by the inclusion of expected losses from government guarantees. There is a
significant increase in total liabilities if the total expected losses are added to the total liabilities
of the GOK. The Figure 5 depicts the rise in total liabilities after inclusion of total expected
losses associated with the guarantees given to statutory organisations and government
companies.

Fig-5: Impact on total liabilities from inclusion of expected losses from

government guarantees, 2020-21, Karnataka

425000
420000
415000
₹. in Crores

410000
405000
400000
395000
390000
Total liability without guarantees Total Liability with Expected loss of
guarantees

Source: Author

The increase in total liabilities with the addition of expected losses from government guarantees
affects its share as a percentage of GSDP as well. For the year 2020-21, the total liabilities were
24 percent of GSDP, from inclusion of expected losses on account of government guarantees
the increase in its share rise to 25.37 percent. Thus, inclusion of expected losses from
government guarantees remarkably increases total liabilities both in absolute sense and as a
percentage of GSDP, thereby impacting on fiscal position. The inclusion thus will alter the
fiscal position of GOK as total liabilities need to be maintained under 25 percent GSDP mark
as per KFRA, 2002.

The CRISIL (2019) study that calculated the probable losses, both expected and unexpected,
on guarantees also suggested the creation of a reserve fund of Rs. 10,157.22 crore (based on the
unexpected losses calculated by the study) and maintain it at the same level for future payments
and losses as well. It is important here to note that the 12th Finance Commission stated that
commission fees must be earmarked for creation of the Guarantee Redemption Fund. The

32
commission fees charged must be used to help off-set any losses or payments that arise on
government guarantee.

In the light of above analysis, GOK need not to create a separate guarantee redemption fund
by setting aside a portion of revenue receipts, but convert the commission fees received into a
fund that could cater to the losses arising on government guarantees. Thus, it is essential for
GOK to ensure that companies and entities provided with guarantees by GOK repay the total
commission fees in a timely manner without any delays.

The addition of expected losses to total liabilities increases the total liabilities in absolute terms
as well as a percentage of GSDP. This increase in total expected losses on guarantees is to rise
in guarantees provided for entities in high and very high risk categories. Hence, GOK must
look into the aspects of financial strength and cash flow management of such entities and advise
them towards more appropriate management of financial aspects so as to shift them from high
risk categories to medium and low risk entities.

33
 CHAPTER 5
MAJOR FINDINGS AND POLICY SUGGESTIONS

This report undertakes a study of guarantees in GOK and default risk associated in it. It also
contributed towards the understanding of losses arising out of government guarantees and
quantifies the associated risks. The analysis is further expanded by calculating the expected
and unexpected losses arising out of guarantees based on their risk characteristics. The main
results and policy implications are given bellow.

5.1 Major findings

The analysis of government guarantees for the period 2016-17 to 2020-21 shows a significant
increase in total outstanding guarantees and its share of outstanding guarantees to total
liabilities in the state. On an average, total outstanding government guarantee in the state has
grown at the rate of 16.42 percent per year and its compound annual growth rate remained at
15.78 percent from 2010-11 to 2021-22. Out of various departments, boards and corporations
nearly 49 percent of the total outstanding guarantees were Water Resource Department as it
covers four major Jala Nigams. Through the guarantees, entities availed the loans from various
financial institutions at a varied range of interest rates. During 2020–21, nearly 38 percent of
the guarantees were borrowed at an interest rate of 8.3 percent by three major entities like
Karnataka State Financial Corporation, Krishna Bhagya Jala Nigam Ltd and Power Company
of Karnataka. Around 82 percent of total outstanding guarantees were availed at the rate of 7-
9 percent of interest rate per annum. Along with principal amount 7-9 percent will be additional
cost to the government.

The report also analysed the rise in government guarantees based on the riskiness of the entities.
The classification provided by the CRISIL (2019) study is used for risk categorisation of all
entities availing government guarantees for the period of 2016-17 to 2020-21. The risk
categories are classified into very low, low, medium, high and very high which have a risk
weights of 0, 20, 60, 80 and 100 percent respectively. The analysis finds that during the study
period, there has been a marked shift towards the provision of guarantees to the high risk
category. Yet, it is well below the 80 per cent of revenue receipts limit as per the KGCC Act,
1999. But the percentage of outstanding guarantees to total revenue receipts had increased from
15.5 percent to 19.8 percent during the studies reference period.
Government guarantees are considered as contingent liabilities and only upon the invocation
of guarantees due to default on payment of interest and/or principal amount are they considered

34
a liability for the government. Therefore, it is very crucial for prudent management of
government to assess the losses that could potentially materialise in the future based on the risk
weights assigned to the entities. The analysis calculated the expected and unexpected losses.
As per the recommendation of the 15th Finance Commission, the addition of expected losses
from government guarantees to the total liabilities will increase the total liabilities for 2020-21
from 24 percent of GSDP to 25.37 percent of GSDP.
To avoid guarantees default burden on total liabilities, 15th Finance Commission made a
recommendation of creation of a Guarantee Redemption Fund; the analysis in the report
suggests that a guarantee fee can be redirected towards the creation of such a reserve and it be
maintained at the level of unexpected losses for each year. This would ensure sufficiency of
funds to cater to unexpected default on risky government guarantees. Hence, it is essential for
GOK to ensure and fix the time limits to repay the guarantee commission.

5.2 Policy implications

GOK may look into the aspects of financial strength and cash flow management of high risk
entities and advise them towards more appropriate management of financial aspects so as to
shift them from high risk categories to medium and low risk entities. The analysis in the report
implies that the liquidity measure ratios need to be calculated for high risk associated entities
before granting guarantees. Administrative department should prepare a complete risk
assessment report with every sanction for approval of government guarantees. It is mandatory
to review the sectoral guarantees and ceiling limits.

As per the results of the present study, all the power distribution corporations are in the high-
risk category and associated with high expected losses. Hence, the government may consider
the following factors that cause the entities to become high-risk entities: 1) Customer profile
in the licence area: a higher share of agricultural consumers lowers the credit profile, whereas
a higher share of industrial consumers improves the credit profile. 2) Timely infusion of
subsidy and equity grants from Govt. of Karnataka, its primary shareholder. These were the
major factors due to which all the power distribution entities are classified under high risk
category and this required attention to transfer entities from high risk to low risk category.

PSUs operating under the Water Resource Department are categorised as high-risk government
corporations, and their expected loss is also higher than that of other entities. Therefore, the
government should enhance the following risk factors to prevent these eventual situations: 1)
Organizations in Karnataka that carry out large- and medium-scale irrigation projects 2) Since

35
the agency does not create a substantial amount of revenue, government financing is required
to pay the debts; therefore, prompt assistance is crucial.

The entities that are classified as high-risk must concentrate on the following financial aspects
so they can be shifted from high-risk categories to medium- and low-risk categories. As per
Companies Act 2013, the company should disclose the following performance ratios. Viz.,
Current Ratio, Debt Equity Ratio, Debt Service Coverage Ratio, Return on Equity Ratio,
Inventory Turnover Ratio, Trade Receivable Turnover Ratio, Tarde Payable Turnover Ratio,
Net Capital Turnover Ratio, Net Profit Ratio, Return on Capital Employed and Return on
Investment.

These ratio analysis is important for the company to analyse its financial position, liquidity,
profitability, risk, solvency, efficiency, operations effectiveness, and proper utilization of
funds. It also indicates the trend or comparison of financial results helpful for decision-making
for investment by company shareholders. One of the most important reasons to use ratio
analysis is that it helps to understand companies business. Calculating the leverages (financial
leverage and operating leverages) allows the firm to understand the financial risk, i.e., how its
profitability is sensitive to outstanding debt. It is vital to assess the performance of the firms
by analysing their liquidity, profitability, asset management. These ratios are also helpful in
making important decisions and forecasting the future. Hence, the present study suggest that,
it is important for the government to study the above financial ratios of the entities before
granting government guarantees to avoid the unanticipated fiscal risk. (Details of Financial
Ratios are given in the Annexture-1).

Non-commercial entities, which are operating on welfare orientation, or working in non-

competitive environments may be exempted from and risk based contingent analysis. To avoid
the fiscal burden of government guarantees, apart from the revenue items in the balance sheet,
newer sources of internal revenues may be explored, for example asset monetization, Pubic
Private Partnership, Disinvestment and Return to investment. This qualifying criteria acts
checks and balances before granting government guarantees.

Finally lessons for the past good practice of companies which availed the loans through
government guarantees and repaid entire amount, may be useful for present and future for
successful management of government guarantees.

As per CRISIL study the risk factors and triggers by individual PSUs are identified for risk
categorisation and demonstration of risk weights. These risk factors may be taken note as

36
decision criteria for granting government guarantees. The risk and triggers are common for the
PSUs in the departments like Energy and Water Resource Department.

SUMMARY OF POLICY RECOMMENDATIONS

The detailed analyses of recommendations above are summarised below for quick reference of
the policymakers in Government of Karnataka. These recommendations are aimed at short term
(or curative) and long term (or preventive) policy measures for minimising the contingent
liabilities arising out of government guarantees to PSUs in Karnataka.

Short term (or curative) measures

1. Guarantee fee can be redirected into the Guarantee Redemption Fund and it can be
maintained at the level of estimated unexpected losses for each year. This is a case for
funding unexpected liabilities in the context of current outstanding government
guarantees.
2. The available performance ratios as per the Companies Act 2013 of PSUs to be
evaluated to identify the high risk associated with low performance of financial
management entities before granting or extending guarantees, especially for loans with
high interest cost.

Long term (or preventive) measures

1. In addition to the existing sources of revenue items in the balance sheet of PSUs, newer
sources of internal revenues may be explored to enhance their investment requirements
without government guaranteed loans. These new sources may include asset
monetization, Pubic Private Partnership for financing, disinvestment.
2. The risk factors and triggers identified by the CRISIL to classify the entities into various
risk categories may be suggested to the PSUs for the purposes of preventing the default
risk factors associated with the government guaranteed loans from the institutional
sources.
3. Lessons from the good corporate management practices of PSUs, which availed the
loans through government guarantees and repaid entire amount, may be useful for other
PSUs for prevention of default risks of government guaranteed loans to them.
4. Punitive provisions must be made to prevent guarantee fee defaulters. (Presently since
there are no punitive provisions at all with respect to guarantee fee payment evasion
has become a regular practice).

37
5. There must be regular risk categorisation of all the PUSs and the same must be
published immediately, so that PSUs can take necessary steps to improve themselves
on one side and the same also helps government to take more informed and better
decision making with respect to extending or giving government guarantees.

38
 ANNEXURE 1: NOTES ON FINANCIAL RATIOS

1. Current Ratio

The current ratio indicates a company’s overall liquidity position. It is widely used by banks
in making decisions regarding the advancing of working capital credit to their clients. Current
Ratio = Current Assets/ Current Liabilities

2. Debt – Equity Ratio

Debt-to-equity ratio compares a Company’s total debt to shareholders equity. Both of these
numbers can be found in a Company’s balance sheet.

Debt – Equity Ratio = Total Debt/ Shareholder’s Equity

3. Debt Service Coverage Ratio

Debt Service coverage ratio is used to analyse the firm’s ability to pay-off current interest and
instalments.

Debt Service Coverage Ratio = Earnings available for debt service / Debt Service

Earning for Debt Service = Net Profit before taxes + Non-cash operating expenses like
depreciation and other amortizations + Interest + other adjustments like loss on sale of Fixed
assets etc.

Debt service = Interest & Lease Payments + Principal Repayments.

“Net Profit after tax” means reported amount of “Profit / (loss) for the period” and it does not
include items of other comprehensive income.

4. Return on Equity (ROE):

It measures the profitability of equity funds invested in the Company. The ratio reveals how
profitability of the equity-holders’ funds have been utilized by the Company. It also measures
the percentage return generated to equity-holders. The ratio is computed as:

ROE = Net Profits after taxes – Preference Dividend (if any) / Average Shareholder’s Equity

5. Inventory Turnover Ratio

This ratio also known as stock turnover ratio and it establishes the relationship between the
cost of goods sold during the period or sales during the period and average inventory held

39
during the period. It measures the efficiency with which a Company utilizes or manages its
inventory.

Inventory Turnover ratio = Cost of goods sold OR sales/ Average Inventory

Average inventory is (Opening + Closing balance / 2)

When the information opening and closing balances of inventory is not available then the ratio
can be calculated by dividing COGS OR Sales by closing balance of Inventory.

6. Trade receivables turnover ratio

It measures the efficiency at which the firm is managing the receivables.

Trade receivables turnover ratio = Net Credit Sales / Average Accounts Receivable

Net credit sales consist of gross credit sales minus sales return. Trade receivables includes
sundry debtors and bill’s receivables.

Average trade debtors = (Opening + Closing balance / 2)

When the information about credit sales, opening and closing balances of trade debtors is not
available then the ratio can be calculated by dividing total sales by closing balances of trade
receivables.

7. Trade payables turnover ratio

It indicates the number of times sundry creditors have been paid during a period. It is calculated
to judge the requirements of cash for paying sundry creditors. It is calculated by dividing the
net credit purchases by average creditors.

Trade payables turnover ratio = Net Credit Purchases / Average Trade Payables

Net credit purchases consist of gross credit purchases minus purchase return

When the information about credit purchases, opening and closing balances of trade creditors
is not available then the ratio is calculated by dividing total purchases by the closing balance
of trade creditors.

8. Net capital turnover ratio

It indicates a company’s effectiveness in using its working capital.

40
The working capital turnover ratio is calculated as follows: Net Sales divided by the average
amount of working capital during the same period.

Net capital turnover ratio = Net Sales/ Average Working Capital

Net Sales shall be calculated as total sales minus sales returns.

Working capital shall be calculated as current assets minus current liabilities.

9. Net profit ratio

It measures the relationship between net profit and sales of the business.

Net Profit Ratio = Net Profit / Net Sales

Net profit shall be after tax.

Net sales shall be calculated as total sales minus sales returns.

10. Return on capital employed (ROCE)

Return on capital employed indicates the ability of a company’s management to generate

returns for both the debt holders and the equity holders. Higher the ratio, more efficiently is the
capital being employed by the company to generate returns.

ROCE = Earnings before interest and taxes / Capital Employed

Capital Employed = Tangible Net Worth + Total Debt + Deferred Tax Liability

11. Return on investment

Return on investment (ROI) is a financial ratio used to calculate the benefit an investor will
receive in relation to their investment cost. The higher the ratio, the greater the benefit earned.
The one of widely used method is Time Weighted Rate of Return (TWRR) and the same should
be followed to calculate ROI. It adjusts the return for the timing of investment cash flows and
its formula / method of calculation is commonly available. However, the same is given below
for quick reference:

{MV(T1) – MV(T0) – Sum [C(t)]}

ROI = _________________________
{MV (T0) + Sum [W(t) * C(t)]}
Where,

T1 = End of time period

41
T0 = Beginning of time period
t = Specific date falling between T1 and T0
MV(T1) = Market Value at T1
MV(T0) = Market Value at T0
C(t) = Cash inflow, cash outflow on specific date

W(t) = Weight of the net cash flow (i.e. either net inflow or net outflow) on day ‘t’, calculated
as [T1 – t] / T1 Companies may provide ROI separately for each asset class (e.g., equity, fixed
income, money market, etc.).

In the present report, we were not able to analyse these ratios to measure the risk
associated with government guarantees. We needed the balance sheets of each entity to analyse
these ratios. The data on financial indicators and balance sheet of each public sector
undertaking is not available in the public domain, hence, the present report fails to analyse
these performance ratios.

42
 Annexure 2: Information on government guarantees in the budget volumes (2022-23) of GOK
Availability of
Name of the Budget
SN information on Data/Information available Page No
Volume
guarantees (Yes/No)
1. Budget Speech No
2. Budget Highlights No
3. AFS No
*Guarantees given by Government of Karnataka
4. Overview of Budget Yes *Sector wise and class wise maximum amount guaranteed and 14
outstanding guarantees data
Information on guarantee ceilings
* Data on contingent liabilities :Government guarantees
9
* Previous 3 years data on Maximum amount guaranteed
5. MTFP Yes 30
* Outstanding amount of guaranteed
* Percentage of outstanding amount guaranteed to total revenue receipts
of the second preceding year
Miscellaneous General Services:
*Data on revenue from guarantee fee (Accounts 2020-21, Budget
6. Revenue Receipts Yes 54
Estimates 2021-22, Revised estimates 2021-22 and Budget estimates
2022-23)
7. Expenditure Volume-1 No
8. Expenditure Volume-2 No
9. Expenditure Volume-3 No
Housing: (2216-03-101-2-05)
Payment of Government Guarantee Commission- Rajiv Gandhi Rural
10. Expenditure Volume-4 Yes 52
Housing Corporation (Accounts 2020-21, Budget Estimates 2021-22,
Revised estimates 2021-22 and Budget estimates 2022-23)
11. Expenditure Volume-5 No
Other Loans to Industries and Minerals: (6885-60-800-3-00)
12. Expenditure Volume-6 Yes Invoking of Guarantees (Accounts 2020-21, Budget Estimates 2021-22, 57
Revised estimates 2021-22 and Budget estimates 2022-23)
13. Expenditure Volume-7 Yes Roads and Bridges (3054-80-800-0-10) 26

43
 KRDCL-Payment of Government Guarantee Commission (2701
Medium Irrigation (2701-80-190-0-03)
* Karnataka Neeravari Nigama Limited(KNNL)- Payment of
Government Guarantee Commission
* Krishna Bhagya Jala Nigama - Payment of Government Guarantee
(Accounts 2020-21, Budget Estimates 2021-22, Revised estimates 2021- 61
22 and Budget estimates 2022-23)
14. ZP Volume-1 No
15. ZP Volume-2 No
16. ZP Volume-3 No
17. ZP Volume-4 No
BUDGET ESTIMATES 2022-2023
2216-03-101-2-05- Payment of Government Guarantee Commission:
78
Rajiv Gandhi Rural Housing Corporation
Summary of Demands
2230-02-101-0-15 Payment of Government Guarantee Commission:
for Grants and Charged 84
18. Yes KSDC
Appropriations (Part – I
3054-80-800-0-10 KRDCL-Payment of Government Guarantee
& II) 120
Commission
3475-00-800-0-02 Contribution to Guarantee Reserve Fund
126
(Net Expenditure, Add-Recoveries & Transfers, Demand)
Housing
2216-03-101-2-05 Payment of Government Guarantee Commission-
19. Gender Budget Yes Rajiv Gandhi Rural Housing Corporation (Accounts 2020-21, Budget 36
Estimates 2021-22, Revised estimates 2021-22 and Budget estimates
2022-23)
20. Child Budget No
21. SCP TSP No
Budget Estimates
22. Appendix-B (State No
Sector)
Budget Estimates
23. Appendix-B (District No
Sector)

44
 Budget Allocation for
24. No
Urban Local Bodies
Action Taken Report On
25. No
Budget Speech
The Budget Memorandum consists of the particulars regarding 8-22
Guarantees given by Government of Karnataka in respect of loans
raised by the Companies, Corporations, Boards and other Local Bodies.
26. Budget Memorandum Yes Shares taken by Government in several Industrial concerns as on 31st
March of the FY. List of Securities held by this Government and Public
Debt & Amortisation. These particulars are given in Annexures I, II, III 23-47
and IV respectively.
Errata to Budget
27. No
Volumes

This table indicates that out of 27 budget volumes published by GOK, only seven volumes contain information on government guarantees. A
budget overview is included, information on GOK's total guarantees and their sectoral distribution. The MTFP (Medium-Term Fiscal Plan)
included data from previous three years on maximum amount guaranteed, outstanding amount, and percentage of outstanding amount to total
revenue receipts. Data on revenue generated by guarantee fees is given in Revenue Receipts. Expenditure Volumes of 4, 6, and 7 contained
information on the payment of guarantee fee, while volume 6 contain information on the invoking of guarantees. The Summary of Demands for
Grants and Charged Appropriations (Part – I & II) and gender budget has information on payment of guarantee fees. The budget memorandum
consisted the particulars regarding guarantees given by the government of Karnataka in respect of loans raised by companies, corporations, boards,
and other local bodies. It is observed from table that, all the information related to government guarantees given in the budget volume is contingent
in nature and no information on fresh guarantees given in the particular financial year and guarantee commission of particular loan was not provided
in any of the budget volumes.

45
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Mishra, S., Gupta, K., & Trivedi, P. (2020). Subnational Government Debt Sustainability in
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