Insights into Editorial: Review of FRM Act
The government appointed five member committee to review the working of FRBM Act has submitted its report to the government.
Background:
It was over a decade after the Fiscal Responsibility and Budget Management (FRBM) Act kicked in both at the Centre and in the states, the government had announced a five-member committee to review the law in keeping with its budget promise.
Besides reviewing the working of the FRBM, the committee was also mandated to examine the feasibility of having a fiscal deficit range rather than a fixed number as a percentage of the GDP, as is the case now.
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.
- The government was to provide make 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.
Performance of the FRBM Act:
The FRBM Act, 2003 (notified in July 2004) envisaged an annual 0.3 percentage point reduction in the fiscal deficit and a 0.5 percentage point reduction in the revenue deficit to bring the former down to 3% of GDP and the latter to nil by 2008-09. In reality, the fiscal deficit doubled to 6% of GDP during 2008-09, driven largely by the desire to distribute largesse on the eve of the 2009 general elections, and remains close to 5%. Meanwhile, the revenue deficit is nowhere near being eliminated.
Why review of this law is necessary?
- Passed almost three years after it was first introduced in Parliament, that too in a significantly watered down form, the Fiscal Responsibility and Budget Management Act has faced a rocky road in terms of implementation. Paused four times since its enactment in August 2003, including for a reset of the fiscal deficit target in 2008-09 following the global financial crisis.
- A review of some of the provisions of the law may certainly be warranted, especially the limiting of the fiscal deficit to 3% of the GDP, which some economists consider arbitrary and more suited to the West where growth has tapered off.
- The existing FRBM Act also prescribes a target fiscal deficit of 3% of GDP for the centre but with no explicit justification for the number. Since there is also a separate limit for the states, the combined fiscal deficit is much larger.
- Even, the 14th Finance Commission recommended a strong mechanism for ensuring compliance with fiscal targets and suggested an amendment to the existing FRBM Act to form an independent council to assess fiscal policy implications of budget proposals and their consistency with rules. Indeed, it had made out a case for replacing the FRBM with a Debt Ceiling and Fiscal Responsibility legislation by invoking Article 292.
Way ahead:
There is no denying that the Act has helped focus attention on the issues relating to fiscal consolidation — thanks to the mandatory medium-term and strategy statements that the government of the day is required to present annually before Parliament. But with regard to the larger objective of ensuring macro-economic stability, the record has been less than ideal. Both headline consumer price inflation and the debt-servicing costs for the Central government were, at different points in the post-FRBM era, at divergence with the performance of fiscal deficit, raising questions about the over-emphasis on a cast-in-stone target number.
The nub of the issue is this: has the law allowed the government the elbow room needed to use all the fiscal tools at its command to ensure that the growth momentum is maintained, without either significantly fuelling inflation or curtailing spending on vital and socio-economically relevant development programmes? If it has not, this may be the time to review the Act, and if necessary, amend it significantly.
Conclusion:
In conclusion, the adoption of new FRBM framework will enhance the efficacy of India’s fiscal policy and significantly reduce the twin-deficit vulnerability. At a juncture where most developed economies are struggling with their government’s balance sheet to support the economy, a rule-based system with room for independent advisory and oversight can transform India’s fiscal architecture and create enablers for germination of green field investment appetite. However, any exercise of fiscal management should not only be cautious but sensible and far-sighted.
