On 1 February 2017, the finance minister presented the union budget in the parliament where he announced that a committee would be established to review the implementation of the Fiscal Responsibility and Budget Management Act (FRBM Act). The committee will also suggest modifications for the future. The finance minister said FRBM Act, 2003, holds many flaws and these flaws are needed to be reflected on and a truly modern act is a necessity of the time.
Usefulness of FRBM Act
In the past, the FRBM Act was seen as a way of restraining excessive public spending, eliminating revenue deficit and reducing fiscal deficit. The history of FRBM act has been mixed with success and failures in past. In present, the government has proposed to constitute a new panel to review the Act and suggest improvements.
The Indian government followed the Act since its formation in 2003. It was rigorously followed between fiscal-year 2004 and FY08. At that time, the fiscal deficit was brought down steeply and the revenue deficit decreased below 2% of GDP. In 2009, due to general elections, and the global economic crisis, the FRBM act was breached significantly and the fiscal deficit increased up to 6% of GDP. The fiscal deficit continued to increase unnecessarily for another two years. After this, The FRBM was suspended for 1 year and it was revived only in fiscal-year 2012.
After 2014, The NDA government wisely continued with the Act, but it met deviation from the target in fiscal-year 2015. In this period, fiscal adjustment was delayed because of 0.4 % of increment in public investment of GDP. The fiscal deficit in fiscal-year 2016 was surged from 3.5% of GDP to 3.9% of GDP. Despite the increase in fiscal deficit, public investment of the central government remains too low with 2% of GDP because the total public investments made by enterprises and state and local governments public investment adds up to around 8-9 % of GDP.
Problems in FRBM Act and their solutions:
There are three major problems with the Act which are needed to be reviewed.
First, the focus of the FRBM act remains only on the Union budget whereas the government must focus on the consolidated public sector borrowing requirement (PSBR) of the Center, the states and the public sector undertakings (PSUs). India’s PSBR is much higher than the fiscal deficit. In recent years, these two have shifted in different directions. The fiscal deficit of India has been decreasing, but the PSBR has been increasing.
Second, in past too, the revenue deficit of the central government has been high. The FRBM Act targets the elimination of revenue deficit, but there has been revenue surplus in the consolidated public sector for much of the last 25 years, except for a brief period, 1998-2003.
As a result, the central government has been borrowing to meet the finance of consumption expenditure. And the public sector has been investing more than its overall borrowing. So this alone fact gives an erroneous picture of the finances of the central government.
India needs not only more re-investment by PSUs but also more investment by the central and state governments on transport, irrigation, energy and social infrastructure for urban and rural areas. So, it can be said that, if above thing can be done by the central government, then the centre would collect more dividends from PSUs and allocate these to its strategic investment fund.
Third, the fiscal policy should be contra- cyclical in nature so that FRBM would be able to build in automatic rules to guide the scale and scope of such cyclicality. The current Act does not comprise such cyclical flexibility. The result of this was that at the time of global crisis, the government did not have any choice but to breach the FRBM rules. Consequently, the fiscal deficit increased up to 6.5% of GDP and the PSBR was over 8% of GDP.
The establishment of a Fiscal Council, with technical expertise, would be useful to generate the better understanding of the consistency of fiscal view of each budget. It will also be useful to envisage the longer-term fiscal trajectory under the FRBM Act. And as a result, it would certainly improve the quality of Parliamentary insight and also contribute to a more informed public debate.
Ideally, it would be reasonable to say that FRBM Act should not prescribe specific numbers. It should ask the government to present an explicit analysis of the government debt-to-GDP ratio implications and crowding-out implications. It should also ask the government about other important facets of an economy such inflations, and fiscal trajectory at least up to every five years. This would bring out more clarity in the rationale for the target and would guide discussions of departures.