Government guarantees can help persuade private investors to finance valuable new infrastructure, but because costs are hard to estimate, and usually do not show up in the government's accounts, governments can be tempted to grant too many guarantees. One way to ensure that the costs of guarantees are considered alongside their benefits is to agree to them in the budget. If the government sets a limit on total spending and the budget rules count the cost of guarantees, a decision to grant a guarantee can require dropping another spending proposal. The cost of a guarantee therefore becomes the loss of the benefits of the project it displaces. If the costs of guarantees are truly captured in the budget, the need to involve the minister of finance or the cabinet in decisions about particular guarantees is much reduced (Irwin, 2007).
A second way to improve incentives by ensuring that costs as well as benefits are considered is to charge the beneficiary of the guarantee. The charge could be set equal to the estimated value of the guarantee, plus, perhaps, a premium to cover the government's administrative costs. The beneficiary of the guarantee might be considered to be the firm, its lenders or investors, or the ministry promoting the project. If the beneficiary is charged, it must compare the price with the benefits of the guarantee and decide whether the guarantee is worth taking. Charging can thus reduce the chance of the government's issuing guarantees less valuable to the beneficiary than they are costly to the government. Charging can also help draw the government's attention to two possible purposes of a guarantee: to subsidize and to reallocate risk. Charging for a subsidy is, of course, self-defeating. But if the purpose is to subsidize, giving a guarantee may not make sense. Yet if the government's purpose is to protect the firm from risk rather than to subsidize it, charging may be justified (Schick, 2002) [REF. Schick, 2002 "Budgeting for Fiscal Risk." In Government at Risk: Contingent Liabilities and Fiscal Risk, ed. Hana Polackova Brixi and Allen Schick, 79-98.Washington, DC:World Bank.]
Charging won't necessarily affect the firm's profits. If the government offers a guarantee at a fixed price when it solicits bids for a project, the bidders can be expected to reflect the costs and benefits of the guarantee in the price they offer to charge. Thus, the winning firm's expected profits won't depend on the guarantee fee, even if the firm takes the guarantee and pays the fee. The guarantee can be expected to change the distribution of value between customers and taxpayers, but not the distribution of value between these two groups, on the one hand, and the firm, on the other. The main value of charging for the guarantee in this case is to prevent the government from giving the guarantee when the firm values it at less than the price.
One way to charge for guarantees explicitly in contracts is to demand exposure to upside risk in return for bearing downside risk. If the government offers a revenue guarantee, it can insist on sharing revenue above some threshold. If it gives an exchange-rate guarantee protecting the firm from depreciation, it can insist on getting a comparable guarantee from the firm that means the government, not the firm, benefits from appreciation. Doing so also limits the firm's profits when things go well, which may be advantageous if the firm's profits are public knowledge. It is more complex than charging in cash, however: getting the in-kind fee right requires estimating the cost of the revenue-sharing agreement as well as the guarantee.
Trends in Innovative Guarantees Partial credit guarantees (PCGs) cover part of the debt service payment. Provided by a creditworthy guarantor, they improve the credit rating of a borrower's debt issue and thus its market access and the terms of the commercial debt. Debt transactions using such guarantees reflect the hybrid credit risk of the guarantor (for the guaranteed part) and of the borrower (for the rest). The guarantee coverage can be structured flexibly, effectively sharing the credit risk between the lender (or bond investor) and the guarantor. The PRG was designed to protect the investors in the electricity distribution concession against the regulator making decisions that are in conflict with the tariff-setting provisions in the concession agreement. Full credit guarantees, or wrap guarantees, cover the entire debt service in the event of a default, normally obtaining debt terms similar to those of the guarantor. These guarantees are often used by bond issuers to achieve the higher credit rating demanded by capital market investors. Wrap guarantees have been widely used for asset- or mortgage-backed securities in the United States. Companies that provide wrap guarantees are usually known as monoline insurers. Some official agencies also provide such guarantees. Source: Matsukawa and Habeck, 2007 |