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Insights into Editorial: Equity in debt



Insights into Editorial: Equity in debt




An expert committee formed to review the FRBM Act of 2003 has recommended to review the Act. This advice requires attention, given India’s track record.


Important recommendations made by the committee:

  • Maintain the 3% target till 2019-20 before aiming for further reduction.
  • Pare India’s cumulative public debt as a proportion to GDP to 60% by 2023 — from around 68% at present.



With fiscal discipline faltering and the deficit shooting up to 10% of GDP, the FRBM law was enacted to ‘limit the government’s borrowing authority’ under Article 268 of the Constitution. But the target to limit the fiscal deficit to 3% of GDP (by 2009) was abandoned after the 2008 global financial crisis as a liberal stimulus reversed the gains in the fiscal space, creating fresh macro-level instability.


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. Meanwhile, the revenue deficit is nowhere near being eliminated.


Has FRBM Act served its purpose?

The FRBM Act succeeded in disciplining the states, because the states cannot borrow without the permission of the centre, but it was spectacularly ineffective in disciplining the centre. The act failed to reduce centre’s deficit.

Besides, experts argue, such acts are ineffective where Parliament doesn’t function as an effective watchdog. This act can be effective in a presidential system but not in a parliamentary system, where the government can have its way because it commands a majority in the legislature.


Need for limiting borrowings by the government:

  • Excessive and unsustainable borrowing by the government entails a cost on future generations while crowding out private investment.
  • In the past, fiscal irresponsibility has cost jobs, spiked inflation, put the currency in a tailspin and even brought the country to the brink of a default.


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.


Should fiscal targets be flexible?

The most important reason for flexibility is the need to deal with cyclical shocks. The fiscal deficit in the budget is the gap between explicit expenditure and revenue projections, which, in turn, are based on reasonable expectations regarding growth of GDP. If for some reason there is a temporary shock, such as a fall in export demand, or a temporary choking of investment, or poor rains, revenues could turn out to be lower than expected. Expenditures could also be higher for cyclical reasons, for example a drought leading to higher expenditures under the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA). These could increase the fiscal deficit in absolute terms, and if GDP is also lowered, the deficit as a percentage of GDP would be even higher.

  • In a cyclical downturn, it doesn’t make sense to adhere to the earlier deficit target by cutting expenditures or raising taxes. Instead, we should allow the deficit to exceed the target as a contra-cyclical measure. However, it should not be an open-ended departure from the target, but one which ensures that the “structurally adjusted” deficit remains on track.
  • The structurally adjusted deficit is what the deficit would have been if the cyclical shocks had not occurred. And the approach must be symmetric—when positive shocks produce an unexpected gain in revenue, the observed fiscal deficit should be lower than the target.


Way ahead:

A clear fiscal policy framework in tandem with the monetary policy framework already adopted could act as a powerful signal of commitment to macroeconomic stability. The Centre must swiftly take a call on the panel’s recommendations — including for a new debt and fiscal responsibility law, and the creation of a Fiscal Council with independent experts that could sit in judgment on the need for deviations from targets. It is equally critical that States are brought on board, as the 60% debt target includes 20% on their account. Their finances are worsening again even as the clamour for Uttar Pradesh-style loan waivers grows.



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.