Indian investors have a fondness for any and every kind of debt instrument. As long as an institution or bond is backed by the government, it rises in popularity. Over 70% of the bank deposits in India are still held by the public sector banks, despite their bad loan problems. This is purely due to the government guarantee which comes with them. Even though private players deal in insurance business, LIC (Life Corporation of India) still holds the biggest market share of more than 70% due to its sovereign guarantee.
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What is a Sovereign Guarantee?
- It is a promise by the government to discharge the liability of a third person in case of his default.
- Contingent liabilities offered by the Central and the State governments.
- Article 292 and Article 293 of the Constitution of India extends this power to Central and State governments respectively.
What is covered under Sovereign Guarantee?
- The guarantee cover of the Government of India (GoI) only includes the principal and normal interest in case of default.
- GoI will not pay any penal interest or any other charges.
- The Fiscal Responsibility and Budget Management Act, 2003 limits the total guarantee amount to be 0.5% of the GDP in a given financial year. If the amount breaches this level, then the finance minister is required to make a statement in both the houses of the Parliament.
The government has accommodated Rs 3 lakh crore in FY22, which is much higher than the incremental limit of Rs 1 lakh crore as per the FRBM Act. One of the reasons for this was the moratorium on payment of principal payments by the MSMEs due to Covid-19.
Furthermore, during the years, contingent liabilities in the form of guarantees have increased from Rs 1.07 lakh crore in 2004-05 to Rs 4.47 lakh crore in 2018-19.
What are the advantages of Sovereign Guarantee?
- They are flexible.
- It leads to diversification.
- Brings the beneficiary in direct contact with the credit markets.
What is the disadvantage of Sovereign Guarantee?
- They offer a relatively lower rate of interest as compared to other investments since they are more secure.
There are different types of investments which offer Sovereign Guarantees
- Sovereign Gold Bonds (SGB)
- Treasury Bonds
- National Saving certificate (NSC)
- Public Provident Fund (PPF)
- Sukanya Samriddhi Yojana (SSY)
- Other government backed bonds
Have you invested in any sovereign guarantee investments yet? Comment below and let us know.