Given the long-term nature of these projects, contractors are required to provide guarantees to the contracting entities to mitigate the risk of non-delivery and quality as per pre-agreed terms. Until 2022, bank guarantees, which are limited in supply, were the only means to meet guarantee demand in India. Furthermore, they consume a significant portion of working capital, as they are required to maintain huge cash margins and collateral with banks. Even considering banks' non-funded credit CAGR of 22.7%, there will still be a significant shortage of non-funded credit in India over the next 3-5 years as India grows at an unprecedented rate.
Bank guarantee is able to meet only 40% of India's demand in the next 3-5 years. This creates a gap in the system which poses a significant hindrance to infrastructure development in key sectors such as construction (roads and railways), energy, aviation and telecommunications.
Surety bonds were introduced in Budget 2022 as an alternative to bank guarantees. These bonds issued by insurance companies come under the purview of the Insurance Regulatory and Development Authority of India (IRDAI) and premium is charged as a percentage of the guaranteed amount. Importantly, surety bonds generally do not require any cash margin or collateral.
Comments are closed.