THE NEED FOR FISCAL PRUDENCE AND BUDGETARY MANAGEMENT

The Finance Ministry has recently announced the constitution of a five member committee to review the Fiscal Responsibility and Budget Management Act, 2003. The Committee is to be headed by former revenue and expenditure secretary N.K. Singh, and is counting among its members stalwarts like Chief Economic Advisor Arvind Subramanian, RBI Deputy Governor Urjit Patel, NIPFP (National Institute of Public Finance and Policy) director Rathin Roy, and former finance secretary Sumit Bose.[1] The need for the refurbishment of the FRBM Act is perhaps best captured in the following words of Finance Minister Arun Jaitley spoken while he was presenting the Union Budget 2016-17- “While remaining committed to fiscal prudence and consolidation, a time has come to review the working of the FRBM Act, especially in the context of the uncertainty and volatility which have become the new norms of global economy”.[2]

What must be taken note of at the outset is the fact that the financial crisis was a major but not the only reason which made the FRBM Act obsolete. The man behind the legislation, former Finance Minsiter Mr Yashwant Sinha, has gone on record to say that the legislation is as good as dead in its present state. The FRBM Act as it stands today is clearly not enough to ensure fiscal prudence from the Parliament and thus the committee has been given the mandate to- “make its assessment and provide its views on the expected impact of its recommendations on the general government deficit and other FRBM parameters. The committee will also examine and give recommendations on any other aspect considered relevant in relation to the determination and implementation of the FRBM roadmap”.[3]

.The Fiscal Responsibility and Budget Management Act is a legislation enacted by the Parliament in 2003 to bring in fiscal discipline in the country. FRBM is essentially a fiscal sector legislation which set targets for both the central and state governments to reduce their fiscal deficit and eliminate their revenue deficit respectively in a time-bound manner.[4] There was a pressing need to enact the legislation as the rocketing government borrowing and the resultant debts incurred had eroded the financial integrity of the government to a great extent. The government was forced to borrow in the 1990s as it was tackling a high revenue deficit during those turbulent times. Greater borrowings will naturally lead to higher interest payments, and as was observed by the “Task Force on Implementation of the FRBM Act, 2003”-  “In 2000-01 and 2001-02, more than half of the revenue receipts of the Government were used up in merely paying interest on accumulated debt. In the 2004-05 Budget presented on 8^th July, an enormous sum of Rs. 1, 29,500 crores is required to merely pay interest on this accumulated debt”.[5] Indeed, this was the time when interest payments became the largest expenditure item of the government.

As the coffers were being emptied, the need for fiscal prudence was recognized around all quarters and from this chaos emerged the Fiscal Responsibility and Budget Management Act, 2003. To arrest financial imprudence, the government has imposed on itself serious deficit cut targets under the Act. At this juncture, it suffices to note that the important objectives of the Act are inter-generational equity in fiscal management, i.e., debt undertaken for the benefit of the present generation should not be an unreasonable burden on future generations; long-run macro-economic stability; better coordination between fiscal and monetary policy; and transparency in fiscal operations of the government.[6]

Though the Act in its initial undiluted form seemed promising, it has been amended time and again by the governments to conveniently dilate the period of compliance whenever they ‘feel’ the need for the same. Most of the effective provisions of this Act have been relegated to the status of rules thus making the process of changing them easier through executive orders rather than through the amendment process of the Parliament. Two notable amendments to the Act merit mention at this juncture, viz., the 2012 and 2015 Amendment Acts. The 2012 FRBM Amendment Act changed the target of the legislation from “revenue deficit” to “effective revenue deficit”. Simply put, effective revenue deficit is what remains once grants for creation of capital assets are subtracted from the revenue deficit. Effective revenue deficit only takes the expenditure on consumption by the government into account. The 2015 Amendment has extended the target date to March 2018.

THE REGULATORY MECHANISM UNDER FISCAL RESPONSIBILITY AND BUDGET MANAGEMENT ACT AND ITS IMPLEMENTATION

The original Bill mentioned the goal of eliminating revenue deficit and reducing fiscal deficit to two and not three per cent of the GDP. The yearly reduction targets were pegged at 0.5% every year and the date for achieving the target was set at March 2006. All the contingent liabilities were capped at 0.5% of the GDP. This would have acted as a firm and rigid structure, as every change to the targets would have to be made through an amendment, a fine line to tread when dealing with matters as sensitive as public finance.[7]

But once the matter was referred to the Parliamentary Standing Committee, the Bill was significantly watered down.[8] The deadline to achieve the targets was thus extended to 2008, instead of 2006. The fiscal deficit target went up to 3% and yearly targets and caps on contingent liabilities got pushed to the rules. This move was significant because now these targets and caps can be meddled with by a mere executive order and not by an amendment as would have been required had the Act been passed in its original form. The FRBM Act and rules were notified by the then UPA government in July, 2004.

Under the present FRBM Act, it is the duty of the government to stick to deficit targets. This duty is only seldom observed. The Act empowers the Reserve Bank of India to take appropriate measure to control inflation. The government is required to see to it that the fiscal targets are achieved, and the only exceptions that are granted are natural calamities and issues of national security. However, the implementation of the Act was put on hold, interestingly not on either of the exceptional grounds mentioned, but citing the global financial crisis and the need for fiscal stimulus. The targets set under the Act have been postponed several times in later years, as they are but mere rules which can be changed through executive orders. The Act was amended in 2012 to shift the focus to elimination of effective revenue deficit and not revenue deficit and as per the Finance Act of 2015 the target dates for achieving the prescribed rates were further extended by three years to March 2018. Even Budget 2016-17 reiterates the aim to realize the fiscal deficit target of 3% by March 2018, from a target of 3.9% for 2015-16 and a target of 3.5% for 2016-17.[9]

Under the Act, the Finance Minister has to take explain the reasons and take corrective actions if the government fails to adhere to these targets. It is also provided that the government shall end borrowing from the Reserve Bank except for temporary advances and that the RBI will not subscribe to primary issue of central government securities post-2006. In the 2012 amendment, it was also provided to allow the Comptroller and Auditor General of India to periodically monitor compliance with the provisions of the Act. However, the Fourteenth Finance Commission under the chairmanship of Dr Y.V. Reddy remarked that this provision has been inadequate in ensuring compliance.[10]

A notable observation is that states succeeded in controlling their fiscal and revenue deficits, whereas the Act still remained spectacularly ineffective qua the Centre. This is largely due to the fact that States cannot borrow without the permission of the Centre, but Centre being the proverbial last watchman, has no one to watch over it.[11] This in a way gives to the Centre the right to act according to its own wishes and keep adding to the fiscal deficit. Does that mean that the FRBM Act is in itself redundant? The answer to the question posed above has to be in the negative. As of now, even a 0.2% relaxation of the deficit target kicks off a heated debate, which in the absence of the FRBM would not have happened. This, combined with the features upholding accountability and incorporated in the Act itself, stand testimony to the need of the Act.

ROADBLOCKS IN EFFECTIVE IMPLEMENTATION OF THE PROVISIONS OF THE FISCAL RESPONSIBILITY AND BUDGET MANAGEMENT ACT

Though the law after its introduction helped to reduce the fiscal deficit from 3.9% in 2004-05 to 3.1% in 2007-08 (inclusive of unpaid subsidy bills), it shot up to 8% in 2008-09 (inclusive of unpaid subsidy bills).[12] In the financial year 2008-09, the year targets under the initial Act were meant to be achieved, Revenue Deficit was budgeted at a mere 1.1% despite the implementation of the sixth pay commission recommendations, a massive farm loan waiver program and expansion of MGNREGA to all districts of the country. Such a situation is likely to lead to inflation due to the “crowding-out” effect and the unsustainability of high debt to GDP ratios. In short, there was a financial crisis on the horizon in India due to government’s casual fiscal responsibility policies that would have befallen us irrespective of the occurrence of the global financial crisis.[13]

Net financial savings of households is the common pool of financial savings which fund both the government undertakings and the corporate sector. If a huge chunk of these savings is taken by the government to meet its fiscal deficit, the corporate sector is, so to speak, “crowded-out” of the business, as the corpus of funds available to it is reduced significantly. Also, India’s government debt-to-GDP ratio is also alarmingly high, standing at around 65%. India has been able to maintain investor confidence despite such a high ratio because most of the government’s debt is in domestic currency. Since size of the fiscal deficit determines what happens to the government debt-to-GDP ratio over the successive years, it is desirable to bring down the fiscal deficit and consequently, the ratio.[14]

Fiscal rules, such as the ones notified under the FRBM Act are neither sufficient nor necessary to ensure good fiscal behaviour by the government. Montek Singh Ahluwalia argues that this usefulness is best brought out through the effect that these curbs have had on the States and on their financial consolidation.[15] Though it is extremely difficult to ensure such vigilance in a Parliamentary system, it can at least help spur a spirited discussion in the Parliament and have an impact on public opinion and highly susceptible market expectations.

Mr Ahluwalia contends that it is better to have transparent and credible fiscal rules which can be flouted than to have ineffective and poorly drafted rules or even worse, to have no rules at all. There seems to be no empirical grounding of the 3% ceiling for fiscal deficit. Also, to equate deficit of the Central Government with the deficit of the country is rather misleading.[16] Since under the Act there is a separate, though unspecified limit for the States, the general government deficit is much larger than a mere 3%, even under ideal conditions. In fact, the Fourteenth Finance Commission has recommended a 3% deficit target for the centre and another 3% for the States, thus adding up to a total deficit target of 6%.[17]

REVAMPING THE FISCAL RESPONSIBILITY AND BUDGET MANAGEMENT ACT: PROPOSED REFORMS AND THE WAY FORWARD

The Committee to revamp FRBM has been set up to examine the feasibility of having a fiscal deficit range instead of a fixed number as a percentage of GDP. It is argued that this will give the government greater flexibility and allow it to effectively tackle any exigencies that might arise. It is also within the committee’s mandate to study the feasibility of aligning the fiscal expansion or contraction with credit expansion or contraction in the economy. The committee will also look into the various factors, aspects and considerations going into determining the targets predetermined under the FRBM Act.[18]

There is an imperative need for a new FRBM Act with greater powers and for the establishment of an independent fiscal council. To use Isher Judge Ahluwalia’s words, the FRBM Act should be used as a “chastity belt” only to be loosened with “good reason”. There is a need for a new law which specifically invokes Article 292 of the Indian Constitution.[19] The Fourteenth Planning Commission had recommended a new law called the Debt Ceiling and Fiscal Responsibilities Act which specifically invoked and drew power from Article 292 of the Indian Constitution. The targets set under such an Act cannot be turned into rules which are amenable to change through an executive order, though rules may surely supplement such a law. As many as 30 countries have a body along the lines of an independent fiscal council, and they have all experienced different degrees of success according to the conditions that prevail in the country and its socio-cultural context. If the body is given relatively greater autonomy and the power to have some, but not all of its recommendations enforced, it will truly be a feat in itself and then such a body will be able to operate with some efficacy in the Indian setting.

It would be within the ambit of such a Council to undertake an ex-ante analysis of financial implications of budget proposals and to test them for soundness, simultaneously keeping the long term implications of the proposal in mind. Secondly, this council can also be put in-charge of the cost-benefit analysis of government policies and programmes. Thirdly, such a council can also monitor adherence to fiscal targets during a financial year and flag any likely deviations or stresses. [20] Thus, the Mid-Year Economic Analysis that is undertaken under the current framework can be attributed to a body especially charged with the purpose. For accountability, instead of having the CAG to periodically monitor compliance with provisions and having the finance minister give reasons and taking corrective action, this fiscal council can be made to report directly to the Parliament. It can exert moral pressure on the government to be fiscally prudent and thus ensure compliance with the targets.[21]

What is needed at this juncture is an ex-ante review which sees to it that fiscal responsibility is maintained and not violated. FRBM Act should not require specific numbers as the targets, but instead go for a range keeping in mind the crowding-out effect and sustainability of the government debt-to-GDP ratio discussed above.[22]  Another step that can be taken is apportionment of the total deficit between the Centre and the States.[23] Though past practice allows each State to borrow up to the extent of 1% of its Gross State Domestic Product (GSDP), this lending should be restricted and States with high debt ratios or low growth potential can be helped not with more borrowings but with more grant funds.[24] However, a pertinent question that Mr Ahluwalia fails to address is that how does the Centre with its own deficit to tackle come up with a grant-in-aid for such States? It can only do so by borrowing itself, making the grant redundant or it can reduce the grants allocated to the relatively more well-off States thereby stifling the developmental programmes undertaken in such States.

As has already been argued, flexibility in defining the fiscal deficit target is needed to deal with cyclical shocks. However at times, we may allow the deficit to exceed the target as a contra-cyclical measure. The quality and precision of our national accounts should be improved and it should be recognized that a finance council would only strengthen the working of the Finance Ministry, which up to now has been the lone protector of fiscal prudence.[25] Working on the assumption that the source of all investments made in the PSUs and PSEs is from the borrowings made by the government, it is logical to transfer equivalent amount of borrowings from the government’s books to a central holding company, christened as “Central Holding Company Ltd.” (CHCL), which will hold equity in PSUs. It is asserted that since a lot of money is being pumped in PSUs, and no proportionate income is accruing from them, it is leading to the creation of fiscal deficit. Thus, to avoid this sorry state of affairs, PSUs and PSEs have to be separated from the Consolidated Fund of India. Investment of central government will be transferred to the CHCL and then outstanding Government of India loans would be transferred to the same company. In this manner, the value of investment transferred by the Government of India and the amount of Government of India loans transferred would be equal. Any consequent disinvestment proceedings shall accrue to the CHCL and the redemptions of the loan would be made by the CHCL. Thus, with the researcher concluded his analysis on revamping the Fiscal Responsibility and Budget Management Act, 2003 and the avenues that can be taken to achieve the same.

[1] ENS Economic Bureau, Finance ministry announces 5-member panel to review FRBM Act, The Indian Express (May 18, 2016) available at http://indianexpress.com/article/business/economy/finance-ministry-announces-5-member-panel-to-review-frbm-act-2806039/ (Last visited on September 5, 2016).

[2] Id.

[3] ENS, supra note 3.

[4] P. Kaswan, Revenue Deficit and Fiscal Deficit, simply decoded (March 25, 2013) available at http://www.simplydecoded.com/2013/03/25/revenue-deficit-fiscal-deficit (Last visited on September 5, 2016).

[5] Report of the Task Force on Implementation of the Fiscal Responsibility and Budget Management Act, 2003, 1 (2004).

[6] Fiscal Responsibility and Budget Management Act, 2003.

[7] Seetha, The FRBM Act Needs More Teeth, Swarajya (February 15, 2016) available at http://swarajyamag.com/economy/strong-frbm-act-is-the-time-right-to-loosen-the-chastity-belt (Last visited on September 5, 2016).

[8] Id.

[9] Budget 2016.

[10] 14^th Report of the Finance Commission of India, (2014).

[11] Seetha, supra note 7.

[12] T. Jose, What is Fiscal Responsibility and Budget Management (FRBM) Act? What are the amendments to it?, (2016) available at http://www.indianeconomy.net/splclassroom/223/what-is-fiscal-responsibility-and-budget-management-frbm-act-what-are-the-amendments-to-it/ (Last visited on September 5, 2016).

[13] Seetha, supra note 7.

[14] M.S. Ahluwalia, Time for a brand new FRBM Act, Livemint (March 30, 2016) available at http://www.livemint.com/Opinion/jsgoPSQ6WRh3eQo2p7ZsJL/Time-for-a-brand-new-FRBM-Act.html (Last visited on September 5, 2016).

[15] Id.

[16] Ahluwalia, supra note 14.

[17] 14^th Report of the Finance Commission of India, (2014).

[18] Press Trust of India, Govt sets up FRBM committee on fiscal deficit range, The Times of India (May 17, 2016) available at http://timesofindia.indiatimes.com/city/delhi/Govt-sets-up-FRBM-committee-on-fiscal-deficit-range/articleshow/52313019.cms (Last visited on September 5, 2016).

[19] Seetha, supra note 7.

[20] Seetha, supra note 7.

[21] Seetha, supra note 7.

[22] Ahluwalia, supra note 14.

[23] Ahluwalia, supra note 14.

[24] Ahluwalia, supra note 14.

[25] Ahluwalia, supra note 14.