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FRBM report hints at greater fiscal discipline standards…

Economy | Published on Apr 25th 2017 | Comment(s) 0
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The Fiscal Responsibility and Budget Management (FRBM) Act was passed in 2003 to bring about an institutional mechanism to keep fiscal deficit under check. Fiscal deficit represents the deficit of the government that has to be met through borrowings as it is the gap that cannot be met through a combination of revenue and capital receipts. Normally, a high Fiscal Deficit as a percentage of the GDP is considered to make an economy vulnerable to currency and financial shocks. The FRBM Committee headed by N K Singh was tasked with the job of preparing and submitting the latest report. The report was handed over to the Prime Minister on January 23rd 2017 but it was only on April 12th that the key contents of the report were made public. Let us understand the key highlights of the FRBM report…

Key highlights of the FRBM Committee Report and major takeaways…

•    The FRBM Report has first and foremost recommended the scrapping of the FRBM Act of 2003 and replacing it with a new act together. The government of late has been extremely stringent on fiscal targets and offers very little by way of leeway. The committee wanted the new FRBM to reflect this changed mindset within the government.

•    The FRBM Report has suggested targeting a gliding down of fiscal deficit to 2.5% of GDP by year 2023. This will be done in a progressively graded manner. The first target will be to achieve 3% fiscal deficit between the years 2018 and 2020. The fiscal deficit will then be progressively brought down to 2.8% in 2021, 2.6% in 2022 and finally to 2.5% in 2023, where it is expected to sustain.

•    The committee has also recommended a ceiling of 1% for revenue deficit as percentage of GDP by 2023 when the fiscal deficit target of 2.5% is achieved. Revenue deficit underscores the excess of revenue expenses over your revenue income. In technical parlance, this is almost akin to borrowing for your morning breakfast. In fact, the currency crisis that India had to face in 2013 was largely an outcome of the revenue deficit touching a high of 5% of GDP, an absolutely unsustainable scenario.

•    While Indian government debt is still much more comfortable compared to other countries like Japan and China, the committee has focused on setting distinct limits for government debt too. For the fiscal year 2017, the government debt / GDP ratio stands at 49.4%. The committee has recommended for steadily and progressively reducing this ratio to 38.7% by 2023 to coincide with the fiscal deficit and the revenue deficit targets. The committee has also favoured separate limits for state debt and central debt.

•    Like in any such convention, the committee has also given an escape clause wherein leeway will be offered in case of economic emergencies. The extent of leeway has been fixed at a maximum of 0.5%, which means a fiscal target of 2.5% can be extended to a maximum of 3% in an extreme emergency situation. Dr. Urjit Patel, who is a member of the FRBM Committee, has actually dissented to this limit and wanted the escape leeway reduced to 0.3% from 0.5%.

•    It is also interesting to understand what constitutes an economic stress when this escape clause can be invoked. Interestingly, the committee has also suggested that whenever growth is better than promised, the government may voluntarily to reduce the fiscal deficit targets appropriately. The committee has defined 3 distinct cases when these concessions in the case of economic stress can be invoked…

o    The fiscal deficit can be expanded within the 0.5% limit under situations of natural calamities, considerations of national security, acts of war, collapse of agriculture etc.
o    The government being forced to undertake very far-reaching fiscal reforms which may make the maintenance of fiscal targets unsustainable.
o    In deflationary conditions where there is a clear contraction in output, consumer spending and employment with likely negative implications.

•    Lastly, the committee has also made a very important structural suggestion. Currently, the FRBM has a purely advisory role. It does not have the powers to insist on adherence to the FRBM targets that have been set out. The committee suggests that the FRBM Committee be given such regulatory and operational powers to ensure that they can monitor and enforce such fiscal discipline. Whether such a move is really feasible in the current context remains to be seen.

Whether the strict FRBM targets will be productive or counterproductive only time will tell? But the move towards very measurable and accountable fiscal discipline is a move in the right direction. There are always two schools of thought. On the one hand, the likes of Dr. Urjit Patel are entirely in favour of stricter fiscal discipline, more stringent criteria for availing concessions and enforcement even it means economic pain. On the other hand, economists like Arvind Subramanian have called for looser fiscal policy to be conducive to the rapid strides that India wants to make on the GDP front. 

The last word on the subject may not yet have been said!




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