NEW DELHI: The Centre aims to ease cash concerns for smaller enterprises by scrapping stiff performance bank guarantees required for government contracts, two officials aware of the discussions said. Instead, the government plans to marshal existing schemes to support the performance requirement, potentially freeing up working capital totalling trillions of rupees for enterprises that form the backbone of the Indian industry.
The Union ministry for micro, small, and medium enterprises (MSME) is discussing the proposal with the department for promotion of industry and internal trade (DPIIT), the two government officials cited earlier said on condition of anonymity. Many government contracts mandate MSMEs to furnish a performance bank guarantee to compensate the government for potential defaults, burdening small businesses living on thin margins.
According to the first government official cited above, India’s General Financial Rules of 2017 require a performance bank guarantee. “There, our thinking is to bring convergence—there are many credit guarantee schemes run by the government, many of them for MSMEs specifically. So, instead of nudging MSMEs to set up performance bank guarantees, why not link it with the Centre’s credit guarantee schemes and take that option,” the official said.
The proposal is expected bring relief to India’s over 74 million , which account for over 30% of GDP, 35.4% of manufacturing output, nearly 45% of exports, and employs over 320 million people.
Industry stakeholders said the relief would be welcome, particularly as it has been a long-standing demand of the MSME sector, where the vast majority of enterprises are micro units with a turnover of less than ₹10 crore.
“Removal of performance bank guarantees in government-MSME contracts has been a long-standing plea by the industry, as it forces the smaller business to put a significant part of its working capital aside, making any room for business expansion even narrower,” said Vinod Kumar, president of the India SME Forum, an MSME lobby group representing about 100,000 businesses.
The development assumes significance as MSMEs accounted for 50% of the central government’s ₹2.30 trillion procurement of goods and services in FY26. According to the General Financial Rules, 2017, MSMEs that secure a government contract valued at over ₹10 lakh must furnish a performance bank guarantee worth 3-10% of the project value.
A report by private research firm axiTrust in November 2025 estimated that nearly 4.5% of India’s GDP, or about ₹15 trillion, remains frozen in bank guarantees.
According to the plan, the government is considering using these credit guarantees, under which businesses access collateral-free bank loans and the Centre promises to cover lenders’ losses in case of default, in place of performance bank guarantees, which require banks to compensate the government or contracting entity if a business fails to fulfil its contractual obligations.
Industry experts say that replacing performance bank guarantees with government credit guarantees could reduce the financial burden on MSMEs and free up working capital.
“If implemented, this is a positive idea for MSMEs, as performance bank guarantees are an additional burden for anybody; they lead to increased costs for getting that guarantee. The bank will normally ask for collateral, and in most cases fixed deposits will be kept as collateral. For MSMEs, if performance bank guarantees are not a requirement, their liquidity position also improves, and cost of operations also becomes lower,” said R. Gandhi, a former deputy governor of the Reserve Bank of India.
Indian MSMEs face higher risks compared to non-MSMEs, with limited business diversification, as they cannot always compensate for a loss with a profit in another part of the business.
“There are lots of uncertainties that MSMEs face which can lead to business failures. MSMEs are also risk takers, and there can be no 100% guarantee that a contract can be fulfilled. It is always in the interest of an entrepreneur to fulfil the contract, but a MSMEs face higher risks than non-MSMEs, because their capital base is lower. They cannot balance one contract failure with another success, because business is not diversified,” said Veeramani C., professor and director, Centre for Development Studies, a Thiruvanthapuram-based economic policy think-tank.
A performance bank guarantee, issued by a bank on behalf of a contractor to the project owner or buyer, safeguards contractual performance and can be invoked by the buyer if the contractor fails to fulfil its contractual obligations.
In the past, the Centre by refunding performance securities in government contracts when they failed to meet contractual obligations due to the Covid-19 pandemic. Union finance minister Nirmala Sitharaman, in her FY24 budget speech, said, “In cases of failure by MSMEs to execute contracts during the Covid period, 95% of the forfeited amount relating to bid or performance security will be returned to them by Government and Government undertakings. This will to MSMEs.”