Being a government owned entity has its own set of advantages and disadvantages. For instance, these entities are subject to various freebies/special treatments like guaranteed orders in competitive bidding. (Example BHEL). However, at the same time they also have to bear the brunt of fulfilling social obligations (Example:-State Electricity Boards).
Apart from this, some government entities are also entitled to concessional interest rate on loans that are granted by the public sector banks (PSBs). However, the Union Finance Ministry has finally decided to discontinue with this preferential treatment granted to the government undertakings. It has directed the PSBs to adopt a full risk pricing approach when lending to government entities that have poor ratings. The reason being the deteriorating health of such entities. Generally speaking, lending to a government entity is virtually risk free as the repayment of principal and interest is guaranteed. That's because these debts are backed by the government.
However, of late these very government entities have been unable to make timely payment of interest and principal. SEBs are a prime example to that. Air India is another case of an ailing PSU failing to honor its debt. Till now these entities were lent money at base rate irrespective of their rating. And the result of that is for everyone to see. Air India is on the verge of bankruptcy while the accumulated losses at SEBs indicate a potential likelihood of default by them as well.
If PSBs relentlessly lend money to such defunct PSUs the entire banking system could be exposed to risk. Thus, in order to protect the banking system from collapsing a complete risk assessment needs to be done before lending money to such entities. It may be noted that, as per CRISIL, approximately a quarter of the money that is lent to state owned utilities is restructured. Banks have had to recast loans for a number of utilities. This indicates the inherent risk in lending to such PSUs which has to be priced.
However, pricing the risk of default into the loan amount would increase the interest rates to such entities. And this would discourage them to borrow. Although it would lead to a liquidity crunch it is a necessary step to ensure that the Reserve Bank of India (RBI) doesn't head the Fed way!