The move has been prompted by the mounting contingent liabilities of some state governments which have exceeded their consolidated funds.

Under Article 293b of the constitution, states liabilities in the form of guarantees are not allowed to be in excess of their consolidated funds. Uttar Pradesh, for instance, has started defaulting on its state-government guarantees.

At present, Gujarat has the highest outstanding guarantees, accounting for almost 63 per cent of the states aggregate receipts. Other states with high contingent liabilities include Andhra Pradesh (53 per cent), Karnataka (42 per cent) and Maharashtra (38 per cent). Analysts expect Maharashtra's contingent liabilities to touch 45 per cent of its total receipts during the current fiscal onaccount of its huge borrowing through SPVs.

The state has, however, no history of default on loans extended to state public-sector undertakings.

Andhra Pradesh withdrew prohibition last year when it was on the verge of defaulting on its guarantees. The Haryana government also recently withdrew prohibition when its finances were in a mess.

Most of these states are expected to make further guarantees for road and water-supply projects where the capital outlay involved is huge. Maharashtra alone has a commitment of Rs 16,000 crore on water projects in the next few years, which will have to be debt-financed. The states SPV for development of roads -- Maharashtra State Road Development Corporation -- raised Rs 1,200 crore in January and has plans to raise a further Rs 2,000 crore during the current year.

Maharashtra expects to raise Rs 4,000 crore through various bond issues during the current year. The Maharashtra Krishna Valley Development Corporation has already raised Rs 1,475 crore through bonds andexpects to sell another Rs 700 crore during the current fiscal. The state government also plans to raise funds for irrigation projects in Vidarbha, Konkan and the Tapi Valley through bond issues.

Only Gujarat has so far set a ceiling on guarantees that it will give to upcoming projects. The states current contingent liabilities stand at a little over Rs 6,000 crore, while the ceiling has been pegged at Rs 8,000 crore. Gujarat's consolidated fund stands close to Rs 11,000 crore.

These include guarantees for the Gujarat Torrent power project on the basis of the power purchase agreement, and also for meeting the dues of bond-holders of Sardar Sarovar Nigam. The guarantees also include the fund-raising programmes of various financial institutions, including the Gujarat Industrial Investment Corporation and the Gujarat State Finance Corporation.

Banks and financial institutions have, of late, become increasingly wary of picking up debt instruments of state governments unless they have at least aninvestment-grade rating.

INSIGHT
Need to implement ceiling on guarantees

State governments have of late been using their guarantees as a substitute for raising funds on their own account. But the increasing use of such guarantees, going hand-in-hand with a deterioration in state finances, has led to the credit rating of states becoming suspect. This will raise the cost of several bonds issued by state-level corporations, which have a state-government guarantee as backing. Gujarat's example of a cap on state government borrowings should be emulated by the other states, if they want to keep their ratings intact.