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Why you should pay attention?

The report of the Fiscal Responsibility and Budget Management (FRBM) review committee chaired by N.K. Singh was made public in mid-April 2017. The committee has submitted its report to the government ahead of the presentation of this year’s budget.

Everything about Fiscal Responsibility and Management Act (FRBM)

Reason for the Introduction of FRBM Act, 2003

  • The FRBM Act was enacted in 2003 as rising government borrowing and the resultant government debts have seriously eroded the financial health of the government. High revenue deficit due to higher expenditure on subsidies, salaries, defence etc. compelled the government to make big borrowing from early 1990s onwards.
  • With inadequate revenues, government resorted to high level of borrowing. The borrowing again produced high interest payments. In this way, interest payments became the largest expenditure item of the government.
  • To arrest this financial weakness in its budget, the government has taken some serious deficit cut targets by introducing a law in the form of the FRBM.

Objectives of FRBM Act The major objectives of the Act are:

  • Institutionalizing Fiscal Discipline
  • Reduction of Fiscal Deficit
  • Creating transparent Fiscal management system
  • Achieve Inter-generational equity in fiscal management
  • Long-Run macroeconomic stability
  • Better co-ordination between fiscal and monetary policy

Important Provisions of the Act

  • The FRBM rule set a target reduction of fiscal deficit to 3% of the GDP by 2008-09. This will be realized with an annual reduction target of 0.3% of GDP per year by the Central government.
  • Revenue deficit has to be reduced by 0.5% of the GDP per year with complete elimination by 2008-09.
  • The central government shall not borrow from the Reserve Bank of India except by Ways and Means Advances (WMAs) to meet temporary excess of cash disbursements over cash receipts.
  • The revenue deficit and fiscal deficit may exceed the targets specified in the rules only on grounds of national security, calamity etc.
  • The central government to lay before both Houses of Parliament three statements:
    • Medium-term Fiscal Policy Statement
    • The Fiscal Policy Strategy Statement, and
    • The Macroeconomic Framework Statement along with the Annual Financial Statement.

However, due to the 2007 international financial crisis, the deadlines were not met.

FRBM 2.0 – Amendments in FRBM Act, 2003

Union Budget 2012-13 saw introduction of amendments to the FRBM Act as part of Finance Bill, 2012. Concept of "Effective Revenue Deficit" and "Medium Term Expenditure Framework" statement are two important features of amendment to FRBM Act in the direction of expenditure reforms.

  • Effective Revenue Deficit (ERD) and not Revenue Deficit should be reduced to 0% by 31st March, 2015.
  • Fiscal Deficit should achieve the target of 3% by 31st March 2017.
  • “Medium Term Expenditure Statement be placed before Parliament along with this budget”

Budget 2016-17

  • As per the Union Budget 2016-17, the government constituted a Committee to review the implementation of the FRBM Act.
  • The committee was headed by Former Revenue Secretary and Rajya Sabha MP, NK Singh. Its members were former Finance and Revenue Secretary Sumit Bose, Chief Economic Adviser (CEC) Dr. Arvind Subramanian, Deputy Governor of RBI Urijit Patel and Director of National Institute Public Finance and Policy (NIPFP) Rathin Roy.
  • While remaining committed to fiscal prudence and consolidation, Budget stated that a review of the FRBM Act is necessary in the context of the uncertainty and volatility in the global economy.
  • The panel was also stated to consider the possibility of replacing absolute fiscal deficit targets with a target range.

N K Singh Committee Recommendations:

  • It has recommended Debt (Combined Debt of the Centre and States) as the new anchor and not the Fiscal Deficit.
  • The panel has recommended enacting a new Debt and Fiscal Responsibility Act after repealing the existing Fiscal Responsibility and Budget Management (FRBM) Act.
  • It has recommended a debt-to-GDP ratio of 38.7% for the central government, 20% for the state governments together and a fiscal deficit of 2.5% of GDP (gross domestic product), both by financial year 2022-23.
    • At present the ratio of India’s debt to gross domestic product (GDP) is estimated at a staggering 70%—among the worst among other comparable economies. The plan is to bring this down to 60%.
  • Revenue deficit-to-GDP ratio has been envisaged to decline steadily by 0.25 percentage points each year from 2.3% in 2016-17 to 0.8% in 2022-23.
  • The panel has recommended the administration of the new fiscal rules be vested with a new body manned by experts: Fiscal Council under the Finance Ministry.
    • The proposed three-member fiscal council will prepare multi-year fiscal forecasts for the central and state governments
    • They will also provide an independent assessment of the central government’s fiscal performance and compliance with targets set under the new law.
  • The panel has dispensed with the idea of a band for the new metric. Instead, the panel has proposed specific escape clauses to deal with unforeseen circumstances.
    • The committee has specified deviation in fiscal deficit target of not more than 0.5 percentage points in any circumstance.
  • A similar buoyancy clause has also been proposed so that fiscal deficit must fall atleast 0.5% below the target if the real output grows 3% faster than that of the average.

Implications of the New Fiscal Rules

  • India's sovereign credit rating is likely to improve by shifting the anchor to Debt from Fiscal Deficit. This improved credit rating will help in cheap borrowing from abroad.
  • The creation of fiscal council would have several advantages:
    • A Fiscal Council, with technical expertise, would help generate better understanding of the consistency of fiscal stance of each budget with the longer-term fiscal trajectory envisaged under the FRBM Act.
    • Improving the quality of Parliamentary oversight.
    • Contributing to a more informed public debate.
  • Having institutions like Monetary Policy Committee and Fiscal Council, there could be perhaps greater congruence between monetary and fiscal policy.
  • The new fiscal rules have also considered the need for flexibility in fiscal targets. This is important because a fixed deficit target can pose problems if there is a cyclical downturn in GDP.

Conclusion

The recommendations of the report need to be seen as the broad architecture to move the country towards a new fiscal era. This would bring a paradigm shift in Fiscal Management.

Prelims Related Concepts

  • • Public Debt includes internal debt comprising borrowings inside the country like market loans; borrowing from the RBI on the basis of special securities bills; and external debt comprising loans from foreign countries, international financial institutions, NRI deposits etc.
  • External Debt is the portion of a country's debt that was borrowed from foreign lenders including commercial banks, governments or international financial institutions.
  • Effective Revenue Deficit is the difference between revenue deficit and grants for creation of capital assets
  • "Medium-term expenditure Framework" statement set forth a three-year rolling target for expenditure indicators.

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