Paper & Topic: GS III à Indian Economy

Introduction:

Fiscal Responsibility and Budget Management (FRBM) Act was enacted in 2003. The objective of the Act is to ensure inter-generational equity in fiscal management, long-run macroeconomic stability, better coordination between fiscal and monetary policy, and transparency in the fiscal operations of the Government.

It provides a legal and institutional framework for fiscal consolidation. It is now mandatory for the Central government to take measures to reduce the fiscal deficit, to eliminate revenue deficit and to generate revenue surplus in the subsequent years. The Act binds not only the present government but also the future Government to adhere to the path of fiscal consolidation.

Body:

Performance of FRBM Act:

The implementation of FRBM Act/FRLs improved the fiscal performance of both centre and states.

The States have achieved the targets much ahead the prescribed timeline.

Government of India was on the path of achieving this objective right in time. However, due to the global financial crisis, this was suspended and the fiscal consolidation as mandated in the FRBM Act was put on hold in 2007-08.

FRBM act has been violated more than adhered to since its enactment. The target fiscal deficit to GDP ratio of 3% for the Union government was achieved only once, in 2007-08, when it was 2.5%. That achievement has yet to be emulated again.

The FRBM Act was amended twice, in 2012 and 2015. The revisions in 2015 shifted the date for achieving the 3% target to 2017-18. By this year, the amended revenue deficit target was put at 2% of GDP.

Budget 2018-19 has proposed amending the FRBM Act again, which will shift the target of 3% fiscal deficit-GDP ratio to end-March 2021. No target has been set for revenue deficit.

Shortcomings of the Act:

Reduction of expenditure in critical sector: While there is a drastic fall in deficits, it has largely been on account of reductions in expenditure in critical sectors of the economy such as education, health etc.

The Union government’s development expenditure as a proportion of GDP has declined over time.

Reduced development expenditure: An analysis of revenue account of the development expenditure by states shows that in almost all sectors of development, there has been a decline in the FRBM era.

Manipulation: Also, at times it has been seen that the government has achieved the deficit targets by manipulating the revenue and expenditure accounts such as curtailing the capital expenditure; demanding interim dividend from Public Sector Undertakings (PSUs) in advance etc.

No force majeure clauses: Further, the FRBM Act ignores the possible inverse link between fiscal deficit (fiscal expansion) and bank credit (monetary expansion). That is, if credit growth falls, fiscal deficit may need to rise and if credit rises, fiscal deficit ought to fall — to ensure adequate money supply to the economy.

Investment starved: Data on money supply growth, bank credit and GDP establishes that both money supply growth and credit expansion have significantly reduced in relation to GDP growth. Thus, the FRBM Act has not only reduced the fiscal deficit but also starved the growing economy from much-needed investment.

Reformation of FRBM needed:

The government should start by defining a clear objective, based not on arbitrary targets but on sound first principles: It should aim to ensure debt sustainability. To this end, the government could adopt a strategy based on four principles.

Remove multiple fiscal criteria: The current FRBM sets targets for the overall deficit, the revenue deficit and debt. Such multiple criteria impede the objective of ensuring sustainability since the targets can conflict with each other, This creates confusion about which one to follow and thereby obfuscating accountability.

Target must not be fixed: Around the world, countries are realising that deficit targets of 3 per cent of GDP and debt targets of 60 per cent of GDP lack proper economic grounding. In India’s case, they take no account of the country’s own fiscal arithmetic or its strong political will to repay its debt. Any specific target, no matter how well-grounded, encouraging governments to transfer spending off-budget such as with the “oil bonds” in the mid-2000s and subsidies more recently.

Focus on one measure for guiding fiscal policy: In this regard, Arvind Subramanian and Josh Felmanwe propose targeting the primary balance. This concept is new to India and will take time for the public to absorb and accept. But it is inherently simple and has the eminent virtue that it is closely linked to meeting the overall objective of ensuring debt sustainability.

Have a long-term plan: The Centre should not set out yearly targets for the primary balance. Instead, it should announce a plan to improve the primary balance gradually, by say half a percentage point of GDP per year on average. Doing so will make it clear that it will accelerate consolidation when times are good, moderate it when times are less buoyant, and end it when a small surplus has been achieved. This strategy is simple and easy to communicate; it is gradual and hence feasible.

Conclusion:

Economic disruption caused by the COVID has prompted calls for a relook at the Fiscal Responsibility and Budget Management Act (FRBM). The introduction of the FRBM in 2003 reflected the belief that setting strict limits on fiscal deficits, both for the centre and the states, was the solution. But this framework didn’t work. It is time to learn from past experience and adapt. Adopting a simple new fiscal framework based on the primary balance could be the way forward.