Fiscal Responsibility and Budget Management Act

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Fiscal Responsibility and Budget Management Act

The FRBM Act 2003 in its amended form was passed by the government to bring fiscal discipline and to implement a prudent fiscal policy. High fiscal deficit was the one major macroeconomic problem faced by Indian economy around 2000. It was argued that high deficits lead to inflation, reduces consumption, result in a crowding out of the private sector investment, rising unemployment and falling living standards of the people. Thus arose a need to institutionalize a new fiscal discipline framework.

Features of FRBM Act:

  •  The revenue deficit should be reduced to an amount equivalent by 0.5% or more of GDP every year, beginning with the financial year 2004-05 and eliminate revenue  deficit by March, 2009,
  •  The fiscal deficit should be reduced by 0.3% or more of the GDP every year, beginning with the financial year 2004-05and bringing it down to 3% of GDP by March 2009.
  •  The Central Government should not provide guarantees in excess of 0.5% of GDP in any financial year, beginning with 2004-05
  •  The Central Government should not assume additional liabilities in excess of 9% of GDP for financial year 2004-05 and progressive reduction of this limit by at least 1 % point of GDP in each subsequent year
  •  The RBI should not subscribe to primary issues of Central Government securities from the year 2006-07.
  •  The Finance Minister to make a quarterly review of trends in receipts and expenditurein relation to budget and place the outcome of such reviews before both the Houses of Parliament.
  •  The Central Government should specifyfour fiscal indicators- Fiscal deficitas a percentage of GDP; Revenue deficit as a percentage of GDP; Tax revenue as a percentage of GDP; Total outstanding liabilities as percentage of GDP.
  •  The Central Government should place in each financial year before houses of Parliament three statements-Medium Term Fiscal Policy Statement; Fiscal policy strategy statement; Macro-economic Framework statementalong with Annual Financial Statement and Demands for grants.
  •  The FRBM Act States that the Central Government shall not borrow from RBI except by way of means and advances to meet temporary excess of cash disbursements over cash receipts.
  •  The revenue and fiscal deficit may exceed the targets specified in Rules only on grounds of national security or national calamity or such other exceptional grounds as the Central Government may specify

FRBM- The Impact and Limitations

  1.  Impact on deficits

FRBM act has been violated more than adhered to since its enactment.

  •  Since its enactment, the act has been paused for four times including a reset of the fiscal deficit target in 2008-09 following the global financial crisis.
  •  In 2010-11, Government replaced revenue deficit with the concept ofEffective Revenue Deficitin the budget documents.
  •   In Budget 2012-13, the finance act changed the FRBM act and it brought in a new commitment of eliminating the effective revenue deficit. The amended rules extended the time for elimination of Effective revenue deficit by March 2015 and bringing down fiscal deficit to 3% by March 2017.
  •   The Act has helped on the issues relating to fiscal consolidation due to the mandatory medium-term and strategy statements which are required to be presented annually before Parliament. Implementing the Act, the government had managed to cut the fiscal deficit to 2.7% of GDP and revenue deficit to 1.1% of GDP in 2007–08.
  1. Impact on development

Has the law been successful to ensure that the growth momentum is maintained, without either significantly fueling inflation or curtailing socio-economic welfare expenditure?

  •  While we notice a drastic fall in deficits, it has largely been on account of reductions in critical sectors of the economy.The Union Government’s development expenditure as proportion of GDP declined in the post FRBM era from 7.49% in 2002-03 to 6.42 % in 2005-06.
  •  An analysis of revenue account of the development expenditure by states shows that in almost all sectors there has been a decline in the post FRBM era. In case of education, it declined from around 2.5 % of GDP in 2002-03 to less than 2.2 % of GDP in 2005-06. In Health sector, the decline has been from 0.6% to 0.49 % and in agriculture, from 0.67 % to 0.58 %. In overall Social sectors, it declined from 4.5 %of GDP to 4.16 % of GDP during the period.

Thus the act and its rules are adverse to social sector expenditure necessary to create productive assets and general upliftment of rural poor of India.

  1. Impact on credit growth

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.

  •  Data on money supply growth, bank credit and GDP establishes that, in the last six years, both money supply growth and credit expansion have halved absolutely and in relation to GDP growth. Even the combined fiscal deficit (fiscal expansion) and credit growth (monetary expansion) as a percentage of GDP has halved from 17.4 per cent in 2009-10 to 8.8 per cent, which is less than nominal GDP growth. Thus the FRBM Act has not only reduced fiscal deficit but also starved the growing economy from much needed investment.
  1.     FRBM Act as a borrowed concept

The 3 per cent fiscal deficit limit which emerged from the famous Maastricht Treaty to form the European Union (EU) in 1992 was applied to Indian context without any modifications.

  •  Fiscal deficit is the quantum amount a nation borrows to meet expenditure. As long as we restrict borrowing to investment needs it does not seem logical to say why a nation should borrow only 3 per cent of its GDP to make investments. The investment needs are independently determined by the structural developments in the economy, its stock of capital and its planned growth profile.

Thus the FRBM Act has faced numerous hurdles in its implementation and has become a subject of animated debate. It is in this context the Finance Minister’s Budget proposal to have a committee to review the implementation of the FRBM Act is right step to ask the question whether the law has served the purposes for which it was envisaged.

The Way Forward

The politics of sound finance in a globalised financial environment is well understood. The FRBM Act has the potential of ensuring macro-economic stability provided it is revised to needs of Indian economy. Further, there are some other approaches which can help:

  •  The possibility of adopting a target range rather than a specific number which would give the necessary policy space to deal with dynamic and volatile situations such as the one India currently faces
  •  Aligning the monetary and fiscal economies so that if bank credit growth falls, fiscal deficit may need to go up.
  •  An autonomous Fiscal Management Review Committee (FMRC) which would conduct an annual independent and public review of FRBM compliance.
  •  Move the annual numerical targets from FRBM rules (which are framed and amended by central Government at whim by gazette notification) to the FRBM act itself
  •  Do away with the ambiguous concept of the Effective Revenue Deficit which is nothing but a jugglery to rewrite revenue expenditure as capital expenditure.

Besides, it must also be ensured that resources gained from this fiscal reset are utilized imaginatively for creation of long-term public assets and putting the country back on her growth tracks.