Fiscal Consolidation & FRBM Act

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Making the Fiscal Policy Efficient - Budget Management, lowering the deficit, Rationalization of Expenditure, Increase the Receipts, Bloated bureaucracy (Excess of Official).

  • Fiscal consolidation is a process where government’s fiscal health is getting improved and is indicated by reduced fiscal deficit.
  • Improved tax revenue realization and better aligned expenditure or Rationalization of expenditure are the components of fiscal consolidation as the fiscal deficit reaches at a manageable level.
  • According to Financial time’s lexicon, “Fiscal consolidation is a reduction in the underlying fiscal deficit. It is not aimed at eliminating fiscal debt.”
  • Excess fiscal deficit produces some adverse effects. For the government it causes interest payment burden and for the economy it produces inflationary effect, and rising interest rate in the economy and leading to crowding out effect.
  • he gains from the economic reforms introduced in India in early nineties could not be sustained for a much longer period.
  • Deficits were widening and by 1999-2000 the combined fiscal deficit (of centre and states) almost reached levels of the crisis year ‘1990-91’.
  • Sustainability of debt too was becoming a major issue.
  • In December 2000, Government of India introduced the Fiscal Responsibility and Budget Management (FRBM) Bill in the Parliament as it was felt that institutional support in the form of fiscal rules would help in setting the agenda for the future fiscal consolidation programmer.
Fiscal Responsibility and Budget Management Act, 2003
Main highlights of the FRBMA, 2003 are as given below:
  1. GoI to take measures to reduce fiscal and revenue deficit so as to eliminate revenue deficit by 31 March, 2008 (which was revised by the UPA Government to March 31, 2009) and thereafter build up adequate revenue surplus.
  2. Rules to be made under the Act to specify annual targets for the reduction of fiscal deficit (FD) and revenue deficit (RD) contingent liabilities and total liabilities.
  3. Bringing FD down to 3% of GDP by 2009 (RD to be cut by 0.5 per cent per annum to get zero and FD by 0.3 per cent per annum).
  4. FD and RD may exceed the targets only on the grounds such as national security, calamity or on exceptional grounds.
  5. GoI not to borrow from RBI except by Ways and Means Advances (WMAs) – Only 2 times yearly.
  6. RBI not to subscribe to the primary issue of the GoI securities from 2006–07 (it means that these government bonds/ papers will become market—based instrument to raise long-term funds by the government).
  7. Steps to be taken to ensure greater transparency in fiscal operations.
  8. Along with the Budget and Demands for Grants, the GoI to lay the following three statements before the Parliament in each
  9. financial year:
    • Fiscal Policy Strategy Statement (FPSS) – Current years Status & Strategy.
    • Medium Term Fiscal Policy Statement (MTFPS) – Rolling target for next three years. (Fiscal, Revenue & Primary Deficit, Tax & Non-Tax Revenue, Central Govt Debt).
    • Macroeconomic Framework Statement (MFS) – All indicator, Inflation & Impact of Macroeconomic level. – Section 3 of FRBM Act.
  10. The Finance Minister to make quarterly review of trends in receipts and expenditure in relation to the Budget and place the review before the Parliament.
Outcome,
  • In the past few years a view has emerged as per which binding the government expenditures to a fixed number may be counterproductive to the economy at large.
  • Due to a hard and fast discipline regarding fiscal targets, some highly desirable expenditures by the government may get blocked, for example—expenditures on infrastructure, welfare, etc.
  • This is why we find a changed stance of the Government of India in the Union Budget 2016–17 regarding the follow-up to the FRBMA. Terming it a new school of thought the Budget suggests two important changes in its fiscal road map:
    • It may be better to have a fiscal deficit range as the target in place of a fixed number as target. This would give necessary policy space to the government to deal with dynamic situations.
    • A need is felt to align fiscal expansion or contraction with credit contraction or expansion respectively, in the economy.
  • In the opinion of the Budget, the government should remain committed to fiscal prudence and consolidation but a time has come when the working of the FRBMA needs a review especially in the context of the uncertainty and volatility which have become the new norms of global economy.
  • In the backdrop of this changed stance, the the Government, in 2016 constituted a Committee to review the implementation of the FRBMA under N. K. Singh.
FRBM Review Committee Recommendations
            The FRBM Review Committee (Chairperson: Mr. N.K. Singh) submitted its report in January 2017. The Committee proposed a draft Debt Management and Fiscal Responsibility Bill, 2017 to replace the Fiscal Responsibility and Budget Management Act, 2003(FRBM Act).
Key recommendations of the Committee and features of the draft Bill are summarised below.
  1. Public debt to GDP ratio should be considered as a medium-term anchor for fiscal policy in India. The combined debt-to-GDP ratio of the centre and states should be brought down to 60 per cent by 2023 (comprising of 40 per cent for the Union and 20% for states) as against the existing 49.4 per cent, and 21 per cent respectively.
  2. Fiscal deficit as the operating target: The Committee advocated fiscal deficit as the operating target to bring down public debt. For fiscal consolidation, the centre should reduce its fiscal deficit from the current 3.5% (2017) to 2.5% by 2023.
  3. Revenue deficit target
    • The Committee also recommends that the central government should reduce its revenue deficit steadily by 0.25 percentage (of GDP) points each year, to reach 0.8% by 2023, from a projected value of 2.3% in 2017.
    • The Committee advised government to follow the golden rule here ie., not to finance government’s day to day expenditure through borrowings. Revenue deficit implies financing of government’s day today activities from borrowings.


  4. Formation of Fiscal Council to advice the government.
    • The Committee advocated formation of institutions to ensure fiscal prudence in accordance with the FRBM spirit.
    • It recommended setting up an independent Fiscal Council.
    • The Council will provide several advisory functions.
      1. It will forecast key macro variables like real and nominal GDP growth, tax buoyancy, commodity prices.
      2. Similarly, it will do a monitoring role, besides advising about the use of escape clause and also specify a path of return.
  5. Escape Clause to accommodate counter cyclical issues:  
    • The Committee noted that under the FRBM Act, the government can deviate from the targets in case of a national calamity, national security or other exceptional circumstances notified by it.  
    • Allowing the government to notify these grounds diluted the 2003 Act.  
    • The Committee suggested that grounds in which the government can deviate from the targets should be clearly specified, and the government should not be allowed to notify other circumstances.
    •  Further, the government may be allowed to deviate from the specified targets upon the advice of the Fiscal Council in the following circumstances:  
      • Considerations of national security, war, national calamities and collapse of agriculture affecting output and incomes.
      • Structural reforms in the economy resulting in fiscal implications, or  
      • Decline in real output growth of at least 3% below the average of the previous four quarters. These deviations cannot be more than 0.5% of GDP in a year.
  6. Fiscal consolidation responsibility for states
    • The Committee observes that state government’s fiscal position is important after greater resource transfer to them (Fourteenth finance Commission award). Now, total state expenditures (as a percent of GSDP) is now even greater than the Centre.
    • Hence, fiscal consolidation should also be made by the states. They should bring down their debt target to 20% of GDP from the current 21%.
  7. Debt trajectory for individual states
    • The Committee recommended that the 15th Finance Commission should be asked to recommend the debt trajectory for individual states. This should be based on their track record of fiscal prudence and health.
  8. Borrowings from the RBI:
    • The draft Bill restricts the government from borrowing from the Reserve Bank of India (RBI) except when:
      • the centre has to meet a temporary shortfall in receipts,
      • RBI subscribes to government securities to finance any deviations from the specified targets, or
      • RBI purchases government securities from the secondary market.
  9. Congruence of Fiscal and Monetary Policy
    • The FRBM Review Committee observed that both monetary and fiscal policies must ensure growth and macroeconomic stability in a complementary manger. For this, the Inflation Targeting (IT) regime and Fiscal Rules (FRs) have to interact with each other.
  10. Review Committee: The draft Bill requires the centre to establish a committee to review the functioning of the Bill in 2023-24.

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