Fiscal Consolidation & FRBM Act: Various Issues

Fiscal consolidation is a process of reducing the government’s fiscal deficit and improving fiscal health of the government. In last two years, India has continued on path of fiscal consolidation due to array of reasons including lesser fuel subsidies, targeted social sector schemes, better tax revenue generation and better aligned expenditure.

In this context, the key highlights of the “Fiscal Monitor” report of IMF are worth mentioning here. These include the following:

• Despite deceleration in the growth causes by demonetisation, India managed to path of fiscal consolidation due to above mentioned reforms.
• The deficit will have a moderate decline in next financial year. The union budget has put in place some growth friendly fiscal adjustment underpinned by expenditure cuts.
• The report expected that nationwide GST would enhance the efficiency of the internal movement of goods and services and will establish a common national market.
• The report recommends to continue on path, keep tab on untargeted subsidies, focus on capital spending, raise taxes on demerit goods and so on.

The story of FRBM Act till date

In 1980s, India saw a sharp deterioration of the fiscal situation, which ultimately culminated in the balance of payments crisis of 1991. Within a decade of economic liberalisation, the fiscal deficit and debt situation again seemed to head towards unsustainable levels. The Fiscal Responsibility and Budget Management (FRBM) Bill, 2000 was introduced by Atal Bihari Vajpayee Government to provide a legal backing to fiscal discipline at both the centre and state level. Under this act, it was mandated that both states and centre would wipe out revenue deficit and cut fiscal deficit to 3% by 2008-09, thus brining much needed fiscal discipline in a period of 5 years. The original act had given numerical targets also as follows:

• Every year the government has to bring down revenue deficit by 0.5% and eliminate it by 2007-08.
• Every year, the government has to bring down fiscal deficit by 0.3% and bring it down to 3% by 2007-08.
• Total liabilities of the Union Government should not rise by more than 9% a year.
• Union Government not to give guarantee to loans raised by PSUs and State governments for more than 0.5% of the GDP in aggregate.
• Union Government mandated to place three more documents along with the budget documents viz. Macroeconomic Framework Statement, Medium Term Fiscal Policy Statement and the Fiscal Policy Strategy Statement.

This act was basically an act for the government and by the government. But then, these targets and efforts towards them got derailed in 2007 global financial crisis. Thus implementation of this act was first postponed and then suspended in 2009. Thus, the act was sulking in neglect. The 13^th Finance Commission had reviewed the FRBM act in 2009 and proposed some amendments. However, these were not so radical and based on them, an amendment of Finance Act, 2012 was carried out which said that apart from the Medium-Term Fiscal Policy Statement, Fiscal Policy Strategy Statement and the Macroeconomic Framework Statement, the Central Government would need to lay a Medium Term Expenditure Framework Statement before Parliament. In 2015, one more amendment was enacted. Now, the change was that instead of targeting the revenue deficit, the FRBM act would target a new concept called “Effective Revenue Deficit”. Effective revenue deficit is the difference between revenue deficit and grants for creation of capital assets. In sum, the change has placed capital expenditure out of the purview of the revenue deficit. Initially, it was planned that the effective revenue deficit was to be eliminated and the fiscal deficit to be kept below 3% by March 2015. However, these targets were revised in the Finance Act 2015, and at present the dates of achievement have been pushed to March 2018.

Various Committees on Fiscal Consolidation:

Two worth mentioning committees on Fiscal consolidation include Vijay Kelkar committee and NK Singh Committee.

Vijay Kelkar Committee

The UPA government had constituted Vijay L. Kelkar committee to devise a fiscal consolidation roadmap for 2012-13 to 2014-15. This committee had made several recommendations including a roadmap for government towards subsidy cuts, oil prices etc. One of the radical recommendations was that the government should raise the prices of food items sold through PDS every time when the minimum support prices are revised. Most of the recommendations were specific to problems of those times only and were ignored.

NK Singh Committee

In May 2016, the Modi Government set up a Fiscal Responsibility and Budget Management (FRBM) Committee headed by N K Singh, former revenue and expenditure secretary and a former MP. This was a high level committee whose members included RBI Governor Urjit Patel, Chief Economic Advisor Arvind Subramanian, former Finance Secretary Sumit Bose, and National Institute of Public Finance and Policy Director Rathin Roy. This committee was asked to review the following:

• Working of this moth eaten act for last 12 years and suggest way forward.
• Define the need and feasibility of aligning the fiscal expansion or contraction with credit contraction or expansion respectively in the economy.
• Examine the need and feasibility of having a ‘fiscal deficit range’ as the target in place of the existing fixed numbers (percentage of GDP) as fiscal deficit target.

This committee had submitted its 4 volume report in recent months. In these reports, it largely confined itself to fiscal consolidation and prudence and suggested some changes.

The NK Singh committee suggested a  draft Debt Management and Fiscal Responsibility Bill, 2017 to replace the earlier Fiscal Responsibility and Budget Management Act, 2003 (FRBM Act). For your examination, the most notable recommendations are as follows:

• The committee asks the governments to continue on the fiscal and revenue deficit targets but they should use debt as primary target to fiscal policy instead of deficits. The government should target 60% debt-GDP target with a 40% limit for the centre and 20% limit for states to be achieved by 2023.
• The government should create an autonomous Fiscal Council with a chairperson and 2 members appointed by central government for four year term. The functions of the fiscal council would be to prepare multi-year fiscal forecasts, recommend changes in fiscal strategy, improve quality of fiscal data and advising the government if it needs to deviate from fiscal targets.
• The government can also deviate from the path on advice of Fiscal Council in cases of national security, war, calamities and collapse of agriculture etc.

Issues in NK Singh Committee Report

The above discussion makes it clear that NK singh committee has recommended another target for governments to follow. In a time when elections are being won on the basis of freebies and promises to waive loans, it does not seem that the central and state government would be serious enough towards achieving these targets.

Conclusion

The tenets of FRBM act were not followed for even few years.  Right now that act is on verge of extinction from statue book; and we may expect another law coming up for government’s fiscal discipline. However, the NK Singh committee recommendations and proposed law also don’t make things streamlined. The proposed multiple targets (one for debt, one for fiscal deficit, another for revenue deficit) with their limits would be impossible to concur with. Instead, the centre could be given a target of fiscal deficit of 3% for 3 years and reduce it to 2.5% by 2022-23 with all states adhering to fiscal discipline.

Towards fiscal discipline, the government may carry out the following steps to improve fiscal consolidation:

• Improving tax realisation by reducing tax avoidance, eliminating tax evasion, enhancing tax compliance etc.
• Enhancing tax GDP ratio by widening the tax base and minimizing tax concessions.
• Extending Direct Benefit Transfer scheme for more subsidies and better targeting of government subsidies.

Although the government has initiated several reforms, those attempts to improve the fiscal responsibility were not sufficient and have been piecemeal.