is-there-a-need-to-suspend-frbm-limits-summary

Context:With coronavirus pandemic ongoing, vast sums of money will be needed for relief and stimulus measures. With this a school of thought has emerged relating to whether an ordinance should be issued to lift the FRBM cap on our fiscal deficit.

The Fiscal Responsibility and Budget Management (FRBM) Act, 2003

Objective

To make the Central government responsible for ensuring “inter-generational equity in fiscal management and long-term macro-economic stability”.

  • It is aimed at preventing profligate spending by a government, so that future generations would not be saddled with the payback burden, inflation could be kept in better control, and the stability assured could set conditions for the economy to expand faster.

Provisions

The Act envisages the setting of limits on the Central government’s debt and deficits as well as mandating greater transparency in fiscal operations of the Central government and the conduct of fiscal policy in a medium-term framework. 

The government is also required to provide the Parliament details of fiscal indicators such as 

  • Fiscal, revenue and primary deficit as a percentage of GDP, 
  • Tax and non-tax revenues as a percentage of GDP
  • Central government debt as a percentage of GDP


 

Targets

 

In May 2016, the government had set up a committee under NK Singh to review the FRBM Act. as it believed that the targets under the act were too rigid.

The committee recommended that the government should target a fiscal deficit of 3 percent of the GDP in years up to March 31, 2020 cut it to 2.8 per cent in 2020-21 and to 2.5 percent by 2023.

 

But the targets were modified again in due course of time,Most recent target includes

  • Fiscal deficit of 3.8% estimated in Revised Estimates (RE) 2019-20 and 3.5% for Budget Estimates (BE) 2020-21.
  • Limiting Debt of the central government to 40% of the GDP by 2024-25.
  • Revenue deficit to be brought down to 0%.

Linkages with the states

  • To ensure that the States too are financially prudent, the 12th Finance Commission’s recommendations in 2004 linked debt relief to States with their enactment of similar laws. 
  • The States have since enacted their own respective Financial Responsibility Legislation, which sets the same 3% of Gross State Domestic Product (GSDP) cap on their annual budget deficits.

Escape clause:Section 4(2)

The Centre can exceed the annual fiscal deficit target citing the following grounds 

  • National security
  • War
  • National calamity
  • Collapse of agriculture
  • Structural reforms and 
  • Decline in real output growth of a quarter by at least three percentage points below the average of the previous four quarters.

 

Arguments for lifting the FRBM cap

  • Unprecedented threat arised due to COVID-19:
    • In the face of threats posed by COVID-19, the country cannot afford to let the FRBM law get in the way of what urgently needs to be done. 
    • The shortfalls due to the revenue gap are likely to worsen and there is no time to fret over our lack of fiscal space. 
  • Need for deficit financing:The Centre may need to put together a rescue package of about ₹10 trillion, and this would surely call for large sums of deficit financing.
  • No signs of extra money on its way:Reports of the government’s regular borrowing schedule suggest it has planned for only a slight pick-up in bond issuance over the next few months.
  • Inadequacies in escape clause of the act:The FRBM law does have an escape clause for emergency expenses, but it is too tiny to help. It only allows a half-percentage point deviation of the fiscal deficit from the glide path.

 

Arguments against lifting the FRBM cap

  • FRBM Act is not an expenditure compressing mechanism, rather an expenditure switching one.
  • The act is helping the governments to switch their expenditure from revenue to capital.
    • The multiplier effect is less than 1 for revenue expenditure and over 2.5 for capital expenditure. 
    • In other words, when the government spends Rs 100 on increasing salaries in India, the economy grows by a little less than Rs 100. 
    • But, when the government uses that money to make a road or a bridge, the economy’s GDP grows by Rs 250.
  • Preventing long term losses by providing a threshold:Keeping a lid on the treasury could be due to the capacity inadequacies of the State, which may not be able to manage enlarged sums effectively.

Way ahead:

  • Governments in these difficult times should review revenue assumptions and expenditure allocations, curb non-essential spending.
  • Careful consideration should be placed on curbing non-essential and discretionary spending, minimising wasteful expenditure, and in finding resources to spend on priority areas.
  • The fiscal response to the crisis should be structured at two levels. 
    • Ensure adequate cash to liquidity constrained households as well as uninterrupted supply of essential goods and services during the lockdown. 

Introduction of bold stimulus package for after the lockdown is lifted.

Image Source:Mint