In Finance parlance, it is said cash is king. Incidentally, government sits over large amount of cash but is not availing the finance benefits of sitting on so much cash. The government cash flow is very different .It is managed by Reserve Bank of India. The earnings by various government departments go into consolidated fund of India and expenditure is also done through consolidated fund of India. In case the expenditure leads earning, RBI honours government cheques till there is no risk of breaching government’s sanctioned expenditure. In case the earning leads expenditure, while there is no risk of government breaching expenditure limits but government also loses on the interest it may get on its earnings.
Advance working capital is once such concept which can help government in leveraging the benefit of having RBI as its banker. The Government departments do a lot of work like build roads, buildings, railways etc. In all these cases, the work is done by contractors or companies at a particular cost. In most of the cases, the contractor is supposed to complete the work and then his bills are passed. But to do this work, contractors need working capital which is provided by banks at interest rate varying between 11 to 16 percent. Now, what if government itself gives advance working capital to the contract by securitizing it against a bank guarantee. For example, if someone is giving bank guarantee of 20 percent of the contract value, he may be given advance working capital of 20 percent of the contract value. However, if a contractor wants to avail this provision he should pass on financial benefit of this advance working capital as upfront reduction in the rates. These rates should be fixed a tad below the market rates for working capital.
This concept is likely to yield lot of benefits to organizations, contractors and ultimately public. First of all it will lead to reduction in the cost of work. Thus, government will be able to do more works within the same allotted budget. This in turn is likely to yield benefits to citizenry with more projects being delivered to them. Secondly, it is likely to cut red tapism present in bill passing by smoothening the cash flow to the contractors. Thirdly, it is likely to streamline budget projections and will help in not sanctioning the projects for which funds are not available. Right now, sanctioning of projects is not very accurately linked with future commitments that are likely to accrue. However, advance working capital is likely to hasten bill passing process and thus, will give quite an accurate picture of budget availability at any given point of time.
The advance working capital is also likely to improve the credit flow to contractors and create a growth momentum in the economy. The probability of contractors waiting to get their bill passed due to budget constraints is likely to reduce in this scenario. It is also likely to fasten the execution time of projects as the contractor will not depend on the payments coming from other projects to complete another project. Thus, advance working capital can bring some great advantages to the government. Hypothetically speaking and extrapolating, the government overall expenditure will reduce by around one percent (parameters: 8 percent discount rate and 10 percent bank guarantee) by using this approach which will be a huge amount in absolute monetary terms.
However, any novel concept is likely to have its own pitfalls. Firstly, offering advance working capital without getting upfront discounts in a contract will be self defeating and is not at all recommended. Secondly, Equivalent bank guarantee should be taken from the contractor who is opting for this scheme. Thirdly, Bank guarantee verification should be very accurate and up to date. Fourthly, advance working capital should have some upper cap preferably 25 percent of the annual estimated expenditure of the project. Fifthly, Advance working capital must be recoupable like Imprest. Lastly, some extra cushioning should be provided in the contract to deter misuse of this provision.
Advance working capital is an idea whose time has come. It can really change the way the business is done in the government departments. The project delivery will improve, project cost will reduce and administrative decisions will become more aligned with financial allocations. Thus, a serious debate is very much required on this subject.