Two government guaranteed bond issues in July are expected to be at the start of a wave of state-backed debt. The deals show that the debate between investors and bond issuers about state guarantees is not yet over.

More explicit language is being used to describe what entities states will bailout if necessary

In mid-2009, as the markets worried about Nakheel’s ability to repay a $3.5bn bond, many expected Dubai to repay the debt.

The government showed itself to be willing to let Nakheel default, although ultimately they were repaid. The episode sparked an intense debate among governments, ratings agencies and investors about what would get state support, and what was the value of a guarantee that was not legally binding.

More explicit language is being used to describe what entities states will bailout if necessary. This is good news for investors, who welcome transparency, but problems remain.

State guarantees have not been tested before, and in a crisis governments may decide to ignore them. They also reduce the role of the capital markets in allocating capital. Rather than looking for the best things to invest in, and interrogating management about their ability to deliver, bankers and investors can become lazy. They say that with a guarantee from an oil rich sovereign it does not matter if their business model is overly speculative.

It would be more transparent for governments to just borrow directly and then allocate the capital for strategic projects. Once that project is off the ground and generating income, the project company could then raise debt to repay the government. Qatar has already done some sovereign borrowing to allocate to infrastructure projects, and investors are starting to differentiate between support levels for state-owned firms in Abu Dhabi.

Project companies should be left to borrow on the strength of their own balance sheet, and investors left to decide for themselves how likely state support is.