FRBM Act – A Call For Balancing Fiscal Discipline, Challenges and the Way Forward

Context:

• This article is based on the news “Either Repeal or Revise the Country’s Fiscal Law” Which was published in the Mint. Policymakers have argued that the government has not strictly adhered to the fiscal targets under the Fiscal Responsibility and Budget Management Act (FRBM Act), 2003 and have suggested either repealing or revising the law.

Beyond Budget Deficit Ceilings: A Call for Flexible Fiscal Policies

• They have emphasized on the need for flexible fiscal policies, combining public and private spending.
• It has been suggested that arbitrary limits on budget deficits might not be the most effective approach. 

What is the Fiscal Responsibility and Budget Management Act (FRBM Act), 2003?

• About: FRBM Act establishes financial discipline to reduce fiscal deficit. It aims to manage fiscal deficit, and maintain macroeconomic stability. 
• Objectives
  • FRBM Act aim to introduce transparency in India’s fiscal management systems. 
  • Its long-term objective for India is to achieve fiscal stability and to give the Reserve Bank of India (RBI) flexibility to deal with inflation in India. 
• Key features of the FRBM Act
  • The FRBM Act made it mandatory for the government to place the following along with the Union Budget documents in Parliament annually:
    • Medium Term Fiscal Policy Statement: It lays down the limits on the size of the budget deficits for three years and target for tax and non-tax receipts.
    • Macroeconomic Framework Statement: The macroeconomic framework gives the government’s outlook on growth prospects of the economy. 
    • Fiscal Policy Strategy Statement: FRBM Act explains how the current policies follow sound fiscal management principles and give reasoning for any deviation from the deficit targets set by it under the Act.
  • It sets a target for the Centre’s annual fiscal deficit ratio (FDR) at 3% of gross domestic product (GDP). 
    • The states had to legislate their own FRBM Acts, limiting a state’s FD to 3% of its own GDP.
  • According to the latest road map, the Centre has to bring down its fiscal deficit to 4.5% by 2025-26.
  • The FRBM Act prohibits borrowing by the government from the Reserve Bank of India, thereby, making monetary policy independent of fiscal policy.
  • The FRBM Act bans the purchase of primary issues of the Central Government securities by the RBI after 2006, preventing monetization of government deficit.

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FRBM Act Exemptions/ Escape Clause:  The option allows the government to widen the deficit by 0.5 percentage points in times of exigencies such as a war or calamities of national proportion.

Need of FRBM Act

• Fiscal Discipline: FRBM Act goal was to limit government borrowing and spending in order to reduce fiscal deficits and encourage general financial responsibility.
• Debt Management: The aim is to control the amount of public debt and make sure it stayed within sensible bounds. 
• Fiscal Imbalances: High levels of fiscal deficit and revenue deficit lead to excessive government borrowing having adverse effects on the economy.
• Public Debt Management: Effective debt management is necessary to manage the increasing public debt burden..
• Macroeconomic Stability: The FRBM Act aimed to address unchecked fiscal deficits which lead to inflation, trade imbalances, and overall economic instability.

How effective has the FRBM Act been?

• As per a recent working paper, “Fiscal Policy, Devolution and Indian Economy”, between 2004 and 2008, the Indian government had made giant strides on reducing both revenue deficit and fiscal deficit. 
• However, since the Global Financial Crisis and a domestic slowdown, there have been several amendments to the FRBM Act essentially postponing the targets.
  • India’s fiscal deficit for 2020-2021 zoomed to 9.5% of GDP after the COVID-19 pandemic.
• Thus, the Government of India has not been able to achieve targets set under it. 
• The initial deadline to reach the 3% target was 2007-08 but it has been extended several times over the years. In 2018, the deadline was again extended to 2020-21.
• However, in the FY21 Budget, the target was relaxed to 3.5% as permitted under the FRBM Act. The Centre made use of escape clause to deviate from the fiscal consolidation road map.
• In 2016, a committee under N K Singh was set up to suggest changes to the FRBM Act. 

What are the challenges associated with FRBM Act, 2003?

• Reliance on fixed targets or numbers:  Focusing on a fixed target for the fiscal deficit as compared with a range restricts the government from dealing with dynamic situations typical of market economies. 
  • The requirement to achieve a fixed number has prevented fiscal policy from being countercyclical when needed. 
• Escape clauses: The FRBM Act has also been criticized because of incorporating imprecisely defined fiscal deficit escape clauses and limited accountability in the event of missed targets.
• Weak linkage between policy setting and implementation: This has hindered the ability to promptly and clearly adjust to changes in fiscal policy. 
  • The medium-term fiscal framework was also not closely integrated with the overall fiscal strategy and stance.
  • The transparency and accountability framework has not been able to provide sufficient coverage or assessment of fiscal risks.
• Lack of debt ceiling law:  India’s fiscal rules are mainly focused on traditional budget balance rules with no debt ceiling law.
  • Emerging best practices have moved toward a structural budget balance rule or an expenditure rule.
• Insufficient coverage or assessment of fiscal risks: There was no attempt to assess the potential fiscal risks.
  • Ex-The impact of the announcement of the Pay Commission, the increase in commodity prices and the implications on fiscal policy, the implications of off-budget items such as contingent liabilities.

Way Forward

• Focus on macroeconomic stability: The relevant targets for this are the fiscal deficit, the primary deficit, and the debt/GDP (gross domestic product) ratio.
  • The fiscal deficit and debt ratio of India need to be corrected which are much higher than those of other comparable emerging market countries.
• Focus on capital expenditure: The numerical simulations indicate that fiscal deficit, primary deficit, and public debt ratios all gradually decline as a result of prudently higher capital expenditure. 
  • Thus, India needs to reorient public expenditures toward growth-enhancing investment while maintaining overall fiscal discipline. 
• Clearly defined escape clauses and strengthening the enforcement of fiscal rules: These include measures such as
  • the establishment of independent fiscal councils;
  • full fledged fiscal stability reporting, addressing the coverage of off-budget items like contingent liabilities; 
  • improving linkages between fiscal policy and budget processes; 
  • sharing of responsibilities and coordination within tiers of government for stabilization and sustainability
  • introducing state credit ratings for measuring fiscal performance. 

Conclusion:

The call to either repeal or revise the FRBM Act reflects the ongoing debate over its effectiveness, with challenges including fixed targets, escape clauses, and weak policy implementation. Policymakers advocate for a focus on flexible fiscal policies, emphasizing macroeconomic stability and a need for clear, accountable rules in the face of evolving economic dynamics.

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