Contingent liabilities

Indian Economy glossary

Also called: Sovereign guarantees · Topic: Government Budget, Fiscal Policy and FRBM · NCERT: Beyond NCERT

Meaning

Contingent liabilities are payments the government may have to make in the future, but only if a certain event happens. The main example is a sovereign guarantee (the government's promise to repay a loan taken by a PSU or SPV if that body fails to pay).

  • They are not debt today. They become real debt only if the borrower defaults (fails to repay).
  • They matter because they are a hidden risk. The fiscal deficit (the government's total spending minus its receipts other than borrowing) does not count them. So the Budget can look healthier than it really is.

Explanation

How a guarantee works

  • A PSU or SPV wants a loan. An SPV (special purpose vehicle) is a separate company set up for one job.
  • The government signs a guarantee to the lender.
  • The lender now feels safe, so it lends more easily and at a lower interest rate.

  • No money leaves the government's account on that day.

  • Two possible outcomes:

  • The borrower repays. The guarantee ends and the government pays nothing.

  • The borrower defaults. The government must pay the lender. The promise becomes real spending, and it adds to the deficit and the debt.

  • So a guarantee is a "maybe" debt. The word contingent means "depending on something else happening".

Types and components

  • Explicit guarantees: written, legal promises on loans of PSUs and SPVs. These are the main contingent liabilities in India.
  • Guarantees given in a year vs total outstanding:
  • New guarantees are the ones given during one year. The FRBM cap applies to these.

  • Outstanding guarantees are all the older guarantees that are still live.

  • The Centre gives them. States give them too, for their own bodies such as power companies. State-level off-budget risk is covered under fiscal federalism.

What makes them rise or fall

  • Rise:
  • The government uses PSUs and SPVs to fund projects instead of paying from the Budget.

  • PSUs are in weak financial health, so the risk that a guarantee will be called goes up.

  • Fall:

  • A legal cap on new guarantees (FRBM).
  • Borrowers repay their loans, so old guarantees end.
  • Spending is moved onto the Budget, where it is counted openly.

Worked example (made-up numbers)

  • The government guarantees a ₹10,000 crore loan taken by a power PSU.
  • Year 1: FD rises by ₹0 and debt rises by ₹0. The ₹10,000 crore is only shown as a contingent liability.
  • Year 4: the PSU cannot repay ₹4,000 crore. The government pays the lender.

  • Result: government spending rises by ₹4,000 crore, so the FD rises by ₹4,000 crore. The "maybe" debt has become real.

  • Cap check: if GDP were ₹300 lakh crore, the FRBM cap of 0.5% of GDP would allow new guarantees of up to ₹1.5 lakh crore that year.

In India

  • Law: the FRBM Act 2003 (Fiscal Responsibility and Budget Management Act) caps new guarantees at 0.5% of GDP a year.
  • Audit: the CAG (Comptroller and Auditor General) checks whether the government follows the FRBM Act.

  • Its report on FRBM compliance, presented on 21 July 2025, found that the extra guarantees given by the Centre were 0.23% of GDP in 2022-23. This is within the 0.5% cap [2].

  • Where guarantees are used: loans taken by PSUs and SPVs. The same bodies also raise extra-budgetary resources (EBRs), for example NHAI and IRFC. A disclosure statement on EBRs has come with the Budget since 2019-20.

  • Towards more openness:
  • The 16th Finance Commission wants the definitions of FD and debt widened to include all off-budget borrowing [1].

  • It also wants off-budget borrowing by states to strictly stop [1].

  • Why the debt anchor matters: the Centre's outstanding liabilities are 55.6% of GDP in 2026-27 (BE), and the target is about 50% ± 1% of GDP by March 2031 [1]. If guarantees are called, this debt rises and the target becomes harder to reach.

Don't confuse with

  • Off-budget borrowing / EBRs: this money has already been borrowed and is real debt today. It is simply kept out of the FD. A contingent liability is not yet debt, and it becomes debt only if a default happens. (Example of off-budget borrowing: FCI borrowed from the NSSF to cover unpaid food subsidy.)
  • Fiscal deficit: FD counts actual borrowing in a year. Guarantees are not counted in FD unless they are called.
  • Outstanding liabilities (debt): these are loans the government must repay for certain (55.6% of GDP in 2026-27 BE [1]). Contingent liabilities are payments it might have to make.
  • Public Account liabilities (e.g. NSSF): the government holds this money in trust and must return it to savers. Guarantees are promises made to other people's lenders, and no money comes to the government.

Prelims Hooks

  • Contingent liabilities are mainly government guarantees on PSU and SPV loans. They become debt only if the borrower defaults.
  • Trap: guarantees are not counted in the fiscal deficit when they are given.
  • The FRBM Act 2003 caps new guarantees at 0.5% of GDP a year.
  • CAG finding: the Centre's extra guarantees were 0.23% of GDP in 2022-23, within the cap. The report was presented on 21 July 2025 [2].
  • The CAG audits FRBM compliance. It has also criticised EBRs because they hide the true deficit.
  • The 16th FC recommends widening FD and debt definitions to cover all off-budget borrowing [1].

Mains Points

  • Hidden deficit and credibility:
  • Guarantees, EBRs and off-budget loans make the headline FD look better than the real position.
  • If many guarantees are called at once, debt can jump suddenly and upset the debt path towards 50% ± 1% of GDP by March 2031 [1].

  • Full disclosure builds market trust, and that lowers the government's borrowing costs.

  • A useful tool with a trade-off:

  • Guarantees help PSUs and SPVs borrow cheaply for infrastructure without adding to today's deficit.
  • But they carry moral hazard. A borrower who knows the government will pay may take more risk.

  • The 0.5% of GDP cap and CAG checks [2] limit this risk. A fee linked to risk and regular risk reporting would strengthen them further.

  • Reform link (GS-III, fiscal rules; GS-II, federalism):

  • The 16th FC's call for wider FD and debt definitions [1], the EBR statement (since 2019-20) and moving FCI's NSSF loans onto the Budget (2021-22) all move India towards counting the whole fiscal risk, not only what appears in the Budget.

Related concepts

Read more

Sources

  1. 1PRS Legislative Research, Union Budget 2026-27 Analysisprsindia.org · tier 1
  2. 2PRS, CAG Report Summary: Compliance of the FRBM Act, 2003prsindia.org · tier 1