Demystifying FRBM Act in India

The Fiscal Responsibility and Budget Management Act, 2003 (FRBMA) is an Act of the Parliament of India to institutionalize financial discipline, reduce India’s fiscal deficit, improve macroeconomic management and the overall management of the public funds by moving towards a balanced budget and strengthen fiscal prudence.

Know about FRBM Act,2003

• The Fiscal Responsibility and Budget Management Act, 2003 (FRBMA) is an Act of the Parliament of India to institutionalize financial discipline, reduce India's fiscal deficit, improve macroeconomic management and the overall management of the public funds by moving towards a balanced budget and strengthen fiscal prudence.
• The main purpose was to eliminate revenue deficit of the country (building revenue surplus thereafter) and bring down the fiscal deficit to a manageable 3% of the GDP by March 2008.
• However, due to the 2007 international financial crisis, the deadlines for the implementation of the targets in the act was initially postponed and subsequently suspended in 2009.
• In 2011, given the process of ongoing recovery, Economic Advisory Council publicly advised the Government of India to reconsider reinstating the provisions of the FRBMA. N. K. Singh is currently the Chairman of the review committee for Fiscal Responsibility and Budget Management Act, 2003, under the Ministry of Finance (India), Government of India.

Enactment

• The Fiscal Responsibility and Budget Management Bill (FRBM Bill) was introduced in India by the then Finance Minister of India, Mr.Yashwant Sinha in December, 2000.
• Firstly, the bill highlighted the terrible state of government finances in India both at the Union and the state levels under the statement of objects and reasons.
• Secondly, it sought to introduce the fundamentals of fiscal discipline at the various levels of the government.
• The FRBM bill was introduced with the broad objectives of eliminating revenue deficit by 31 Mar 2006, prohibiting government borrowings from the Reserve Bank of India three years after enactment of the bill, and reducing the fiscal deficit to 2% of GDP (also by 31 Mar 2006).
• Further, the bill proposed for the government to reduce liabilities to 50% of the estimated GDP by year 2011. There were mixed reviews among economists about the provisions of the bill, with some criticising it as too drastic.
• Political debate ensued in the country. Several revisions later, it resulted in a much relaxed and watered-down version of the bill (including postponing the date for elimination of revenue deficit to 31 March 2008) with some experts, like Dr Saumitra Chaudhuri of ICRA Ltd (and now a member of Prime Ministers' Economic Advisory Council) commenting, ‘‘all teeth of the Fiscal Responsibility Bill have been pulled out and in the current form it will not be able to deliver the anticipated results.’’
• This bill was approved by the Cabinet of Ministers of the Union Government of India in February, 2003 and following the due enactment process of Parliament; it received the assent of the President of India on 26 August 2003. Subsequently, it became effective on 5 July 2004. This would serve as the day of commencement of this Act.

Objectives

The main objectives of the act were:

• to introduce transparent fiscal management systems in the country
• to introduce a more equitable and manageable distribution of the country's debts over the years
• to aim for fiscal stability for India in the long run
• Additionally, the act was expected to give necessary flexibility to Reserve Bank of India(RBI) for managing inflation in India.

Content of the Act

• Since the act was primarily for the management of the governments' behaviour, it provided for certain documents to be tabled in the Parliament annually with regards to the country's fiscal policy. This included the following along with the Annual Financial Statement and demands for grants:
• A document titled Medium-term Fiscal Policy Statement – This report was to present a three-year rolling target for the fiscal indicators with any assumptions, if applicable. This statement was to further include an assessment of sustainability with regards to revenue deficit and the use of capital receipts of the Government (including market borrowings) for generating productive assets.
• A document titled Fiscal Policy Strategy Statement – This was a tactical report enumerating strategies and policies for the upcoming Financial Year including strategic fiscal priorities, taxation policies, key fiscal measures and an evaluation of how the proposed policies of the Central Government conform to the 'Fiscal Management Principles' of this act.
• A document titled Macro-economic Framework Statement – This report was to contain forecasts enumerating the growth prospects of the country. GDP growth, revenue balance, gross fiscal balance and external account balance of the balance of payments were some of the key indicators to be included in this report.
• The Act further required the government to develop measures to promote fiscal transparency and reduce secrecy in the preparation of the Government financial documents including the Union Budget.

Fiscal management principles
The Central Government, by rules made by it, was to specify the following:

1. a plan to eliminate revenue deficit by 31 Mar 2008 by setting annual targets for reduction starting from day of commencement of the act.
2. reduction of annual fiscal deficit of the country
3. annual targets for assuming contingent liabilities in the form of guarantees and the total liabilities as a percentage of the GDP

Borrowings from Reserve Bank of India

The Act provided that the Central Government shall not borrow from the Reserve Bank of India (RBI) except under exceptional circumstances where there is temporary shortage of cash in particular financial year. It also laid down rules to prevent RBI from trading in the primary market for Government securities. It restricted them to the trading of Government securities in the secondary market after an April, 2005, barring situations highlighted in exceptions paragraph.

Exceptions
National security, natural calamity or other exceptional grounds that the Central Government may specify were cited as reasons for not implementing the targets for fiscal management principles, prohibition on borrowings from RBI and fiscal indicators highlighted above, provided they were approved by both the Houses of the Parliament as soon as possible, once these targets had been exceeded.

Implementation Targets and fiscal indicators

Subsequent to the enactment of the FRBMA, the following targets and fiscal indicators were agreed by the Central government:

Revenue deficit

• Date of elimination – 31 March 2009 (postponed from 31 March 2008)
• Minimum Annual reduction – 0.5% of GDP
• Fiscal Deficit
• Ceiling – 3% of the GDP by 31 Mar 2008
• Minimum Annual reduction – 0.3% of GDP
• Total Debt – 9% of the GDP (a target increased from the original 6% requirement in 2004–05)
• Annual Reduction – 1% of GDP
• RBI purchase of Government bonds – to cease from 1 April 2006
• Four fiscal indicators to be projected in the medium term fiscal policy statement were proposed. These are, revenue deficit as a percentage of GDP, fiscal deficit as a percentage of GDP, tax revenue as percentage of GDP and total outstanding liabilities as percentage of GDP.

Jurisdiction

• The residuary powers to make rules with respect to this act were with the Central Government with subsequent presentation before the Parliament for ratification. Civil courts of the country had no jurisdiction for enforcement of this act or decisions made therein. The power to remove difficulties was also entrusted to the Central Government.

Criticism

• Some quarters, including the subsequent Finance Minister Mr. P. Chidambaram, criticised the act and its rules as adverse since it might require the government to cut back on social expenditure necessary to create productive assets and general upliftment of rural poor of India.
• The vagaries of monsoon in India, the social dependence on agriculture and over-optimistic projections of the task force in-charge of developing the targets were highlighted as some of the potential failure points of the Act. However, other viewpoints insisted that the act would benefit the country by maintaining stable inflation rates which in turn would promote social progress.
• Some others have drawn parallel to this act's international counterparts like the Gramm-Rudman-Hollings Act (US) and the Growth and Stability Pact (EU) to point out the futility of enacting laws whose relevance and implementation over time is bound to decrease.
• They described the law as wishful thinking and a triumph of hope over experience. Parallels were drawn to the US experience of enacting debt-ceilings and how lawmakers have traditionally been able to amend such laws to their own political advantage.
• Similar fate was predicted for the Indian version which indeed was suspended in 2009 when the economy hit rough patches.

N K Singh Committee

• In recent year there have been persistent calls for review of the same.
• Central government constituted N.K. Singh panel with five-member committee — including Reserve Bank of India Governor Urjit Patel, former Finance Secretary Sumit Bose, Chief Economic Advisor Arvind Subramanian, and National Institute of Public Finance and Policy Director Rathin Roy — was constituted in May 2016.
• The committee constituted following Mr. Jaitley’s announcement, in Budget 2016-17, of the creation of a panel to review the Fiscal Responsibility and Budget Management Act.
• The government has set a fiscal deficit target of 3.5% of GDP for FY17, a lower target than the 3.9 per cent set for 2015-16, which was achieved.
• The context of the committee was that India’s FRBM for the centre and the states had fixed rigid targets for the fiscal deficit that were to be achieved and sustained over the medium term.
• This was done in the context of high debt to GDP levels, and the idea was once discipline is enforced this ratio would fall.
• Many countries have a system of flexibility in fiscal targets, such that in a slowdown it can borrow more than the average provided it borrows less than average during expansionary phases.
• Fiscal management becomes all the more important post-demonetisation and the resultant slump in consumption expenditure, according to experts. The view is that the government could be tempted to increase public spending to boost consumption.

Significance of the Committee

• The Committee was an outcome of intense debate on FRBM implementation.
• There was difference of opinion about the need for adopting a fixed FRBM target like fiscal deficit. Several economists argued that FRBM target which is usually expressed in terms of fiscal deficit, need not be followed during the time when government has to spend high to fight recession and support economic growth.
• Some others argued that a target oriented fiscal deficit (as under FRBM) is necessary to ensure fiscal discipline.
• During Budget speech in 2016, Mr Jaitley expressed this debate: “There is now a school of thought which believes that instead of fixed numbers as fiscal deficit targets, it may be better to have a fiscal deficit range as the target, which would give necessary policy space to the government to deal with dynamic situations. There is also a suggestion that fiscal expansion or contraction should be aligned with credit contraction or expansion, respectively, in the economy.”
• The FM’s voice implicitly demanded a flexible FRBM target which allows higher fiscal deficit during recessionary/difficult years and low targets during comfortable years. Such an arrangement will give more breath to the government to borrow more (more fiscal deficit) during tight years.
• Hence a rethinking on FRBM was initiated by budget 2016 and to make an expert opinion, the NK Singh Committee was formed.

NK Singh Committee’s responsibility

The Committee’s following four terms of references clearly tells its responsibility.

Review of the running of FRBM in the past and suggest changes to meet contingencies:

The Committee has to review the working of the FRBM Act over last since its enactment in 2003 or during the last 12 years. Here, it has to suggest the way forward, keeping in view the broad objective of fiscal consolidation and prudence and the changes required in the context of the uncertainty and volatility in the global economy.

Examining various associated aspects

The committee has to look into various aspects, factors, that have to considered while determining the FRBM targets.

Examining the feasibility of flexible Fiscal Deficit Target

• The Committee has to look into the possibility of a ‘fiscal deficit range’ or flexible fiscal deficit target instead of a fixed target (eg. 3% of GDP as at present) as the target in place of the existing fixed numbers (percentage of GDP) as fiscal deficit; andAligning fiscal activities with credit cycle
• Here, the Committee has to search whether the government need to align or adjust its fiscal expansion/contraction with credit expansion/contraction in the economy.
• Besides looking into the existing FRBM Act in the light of contemporary changes, the Committee has to consider past outcomes, global economic developments, best international practices etc., while recommending the future fiscal framework and roadmap for the country. It has to consider the recommendations of the Fourteenth Finance Commission and the Expenditure Management Commission as well.

Report submitted by the Committee

• The Committee has submitted its report to the Finance Minister on January 23rd 2017. Details of the report is yet to be published by the Ministry. But the it has four volumes:
• Volume 1- Addresses the issue of fiscal policy and roadmap, international experience and the committee’s recommendations on it.
• Volume 2- Refers to view of international organizations like OECD, World Bank, ILO which made presentations before the panel.
• Volume 3 - Deals with Centre-state issues. Each state and the Centre had given their views to the panel, but direct relationship between state-related fiscal issues were “somewhat tenuous”, Singh said. “Responsible growth, debt and fiscal framework, debt issues are pretty frontal in that,” he added.
• Volume 4- Includes views of domain experts, both national and international, and what they believe an appropriate fiscal policy would be.
• Economic Survey 2016-17
• The Economic Survey has called for modifying the Fiscal Responsibility and Budget Management Act, 2003 (FRBM Act) to provide fiscal policy direction for “the India of tomorrow”, but cautioned against fiscal activism adopted by the western world to prop their economies.
• The country’s economic experience shows that the fiscal activism embraced by advanced economies — giving a greater role to counter-cyclical policies and attaching less weight to curbing debt — is not relevant for India.
• It said the country’s fiscal experience has underscored the fundamental validity of the fiscal policy principles enshrined in the 13-year old FRBM Act.
• However, even as the basic tenets of the Act remain valid, the operational framework needs to be modified “for the fiscal policy direction of India of today, and even more importantly the India of tomorrow”, the survey said.

Issue

• The Fiscal Responsibility and Budget Management (FRBM) Review Committee chaired by former Revenue Secretary N.K. Singh has recommended –
• The committee 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.
• The committee has prescribed a so-called glide path to these targets—steady progress towards them—and also suggested that there be some flexibility in the deficit targets on both sides, downwards when growth is good and upwards when it isn’t.
• The Centre can take a pause on the fiscal consolidation front over the next three years by maintaining a fiscal deficit to GDP ratio of 3% till 2019-20.
• The panel has recommended enacting a new Debt and Fiscal Responsibility Act after repealing the existing Fiscal Responsibility and Budget Management (FRBM) Act, and creating a fiscal council.
• In 2016-17, India’s debt-to-GDP ratio for the central government was 49.4% and fiscal deficit at 3.5% of GDP. The government is hoping to end 2017-18 with a fiscal deficit that is 3.2% of GDP, marginally higher than the 3% mentioned in the FRBM Act.
• On the FRBM roadmap for future, the panel has advocated reaching a fiscal deficit to GDP ratio of 2.8% in 2020-21, 2.6% the subsequent year and 2.5% in 2022-23.
• 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 an Escape Clause.

In case of contingencies

• The panel has introduced an escape clause that allows the government to skip the fiscal deficit target for a particular year, in situations that include
• National security concerns; acts of war; national calamities; a collapse of the agriculture sector; and far-reaching structural reforms with unanticipated fiscal implications.
• It recommended that deviations from the stipulated fiscal targets should not be more than 0.5%.
• The Reserve Bank of India governor Urjit Patel was not in favour of such a large deviation.
• Mr. Patel, who was also a member of the panel along with Chief Economic Adviser Arvind Subramanian, was inclined to only permit a 0.3% deviation.
• The escape clause can also be triggered if the economy’s real output growth slips by three percentage points from the average of the previous four quarters.
• A similar buoyancy clause has been proposed, so that fiscal deficit must fall at least 0.5% below the target if real output grows 3% faster than that average.

FRBM to make way for DFRA

• The panel has recommended that the existing FRBM Act and rules be scrapped and a new Debt and Fiscal Responsibility Act be adopted and proposed the creation of a Fiscal Council that the government must consult before invoking escape clauses.

Conclusion

• FRBM Act is a European model of fiscal responsibility. There were concerns of India adopting it as it is. The review panel has suggested relevant reforms with required contingency clauses embedded. As the Economic Survey of the year referenced it is important to remain on the path of fiscal discipline but adopt an Indianised model of the same.