Calcutta, Feb. 21: The Reserve Bank has asked state governments to be cautious while standing guarantee for bonds issued by state agencies and to carry out a credit rating of the bonds.
However, in the same breath, the central bank has informally told banks it will pay the interest and principal on state loans (not guaranteed debt) if they fail to honour them.
When contacted by The Telegraph, senior officials of the Bengal finance ministry said, “The central bank has asked us to be cautious while issuing the guarantees for bonds floated by state agencies and do a credit rating of the bonds.”
The state government gives guarantee on bonds issued by the state agencies to improve investors’ confidence. When the West Bengal Infrastructure Development Corporation issued bonds worth Rs 500 crore the state government had issued guarantee.
Banking industry officials said the RBI is offering the carrot and wielding the stick at the same time by informally underwriting the state’s direct debt while discouraging them from issuing guarantees indiscriminately.
They added that the RBI warning on government guarantee also has important, if only indirect, implications for investors at another level. This relates to the quality of credit associated with companies owned by the state government. Quite a few of such are active deposit takers, often also offering better rates than available elsewhere.
But there is now a signal for the investors to view such options cautiously.
According to bankers, state-guaranteed bond issuances have dropped significantly over the past couple of months.
The RBI has asked banks to tighten their due diligence too when putting money in state and state-backed loans. Bankers admit that the RBI has expressed its disapproval of their investing in such bonds.
In early part of 2002, the central bank had issued a circular advising banks against investing blindly in state-guaranteed paper.
Banks and financial institutions had been told that they must “undertake due diligence on the viability and bankability of such projects to ensure efficient utilisation of resources and creditworthiness of the projects financed”. They had also been asked to ensure that the funds raised by such entities are not used to finance state budgets.
Since state-guaranteed bonds qualify for Statutory Liquidity Ratio (SLR) requirement, banks, both public and private, have been investing heavily in these papers. The dismal condition of many state governments has, however, led to large-scale defaults on these papers.
Bankers said that some of the state agencies even do not pay banks in time during the redemption of bonds. Since the banks have to make full provisioning against the government guaranteed bonds, the RBI has asked the banks to be cautious while investing in them.