Insights into Editorial: What sort of new FRBM do we need
The report of N.K. Singh committee to review the Fiscal Responsibility and Budget Management Act (FRBMA), 2003, has been made public. However, there’s no indication as to whether the government will accept these recommendations.
Important recommendations made by the committee:
- A debt-to-GDP ratio of 40% 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.
- There be some flexibility in the deficit targets on both sides, downwards when growth is good and upwards when it isn’t.
- Enact a new Debt and Fiscal Responsibility Act after repealing the existing Fiscal Responsibility and Budget Management (FRBM) Act, and creating a fiscal council.
- Compose a three-member fiscal council to prepare multi-year fiscal forecasts for the central and state governments (together called the general government) and provide an independent assessment of the central government’s fiscal performance and compliance with targets set under the new law.
- 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.
- To deal with unforeseen events such as war, calamities of national proportion, collapse of agricultural activity, far-reaching structural reforms, and sharp decline in real output growth of at least 3 percentage points, the committee has specified deviation in fiscal deficit target of not more than 0.5 percentage points.
What’s good about these recommendations:
- The committee has recommended reducing the Centre’s debt to GDP ratio from 49.4% in 2016-17 to 40% by 2022-23. The states’ debt ratio is targeted to remain at around 20%. The combined debt of the Centre and the states is targeted to go down from 68% in 2016-17 to 60% by 2022-23. The 60% debt target for the Centre and the states combined is an improvement from 68% in 2016-17, but it is still much above the average of about 40% for similarly rated emerging market countries. However, since our growth rate is also much higher, a 60% debt ratio may be accepted as a reasonable target.
- The committee has 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. Lower growth means lower revenue, which means expenditure has to be reduced to keep the absolute level of the deficit on target. The lower GDP will also reduce the denominator in the fiscal deficit ratio, which means the absolute size of the fiscal deficit will have to be lower than originally projected to keep the deficit as a percentage of GDP at the targeted level. Both factors will force a contraction in expenditure, which would worsen the cyclical downturn.
- The committee has therefore recommended an “escape clause” which would enable departure from the fiscal deficit target in specific circumstances. The proposal clearly improves over past practice because the escape will be possible only on the recommendation of the Fiscal Council (on which more below) combined with some assurance of a planned return to the original target.
- The recommendation to create an independent Fiscal Council is a major institutional reform. Many countries have established such councils and our doing so will add to the credibility of the new system.
What is FRBM Act?
Fiscal Responsibility and Budget Management (FRBM) Act was enacted by Parliament in 2003 to progressively cut fiscal deficit to 3% levels by 2008.
- FRBM Act put limits on the fiscal and revenue deficit of the country by setting targets for both. These targets were to be monitored through the year by setting mid-year targets.
- As per the act, the government has to provide a medium-term fiscal policy statement, fiscal policy strategy statement and macro-economic framework statement to Parliament.
- The Act, however, provides exception to government in case of natural calamity and national security.
Need for a new act:
A new Act is needed because the existing FRBMA has proved ineffective. It was suspended with impunity in 2009, for several years, during which the fiscal deficit went out of control. There was also non-transparency which allowed the deficit to be seriously understated. The lesson is not that fiscal rules are useless, but that the old Act was flawed, and we need something better.
It is then clear that the country needs a new fiscal framework. We can rue the fact that it should have happened sooner. But as the cliche goes: Better late than never.