Indian economy faced with the problem of large fiscal deficit and its monetization spilled over to external sector in the late 1980s and early 1990s.
The large borrowings of the government led to such a precarious situation that government was unable to pay even for two weeks of imports resulting in economic crisis of 1991.
Consequently, Economic reforms were introduced in 1991 and fiscal consolidation emerged as one of the key areas of reforms. After a good start in the early nineties, the fiscal consolidation faltered after 1997-98.
The fiscal deficit started rising after 1997-98. The Government introduced FRBM Act,2003 to check the deteriorating fiscal situation.
FRBM Act provides a legal institutional framework for fiscal consolidation. Fiscal Responsibility and Budget Management (FRBM) became an Act in 2003. The objectives of the Act is
• To ensure inter-generational equity in fiscal management
• Long run macroeconomic stability
• Better coordination between fiscal and monetary policy, and
• Transparency in fiscal operation of the Government
The Government notified FRBM rules in July 2004 to specify the annual reduction targets for fiscal indicators. The FRBM rule specifies reduction of fiscal deficit to 3% of the GDP by 2008-09.
Similarly, revenue deficit has to be reduced with complete elimination to be achieved by 2008-09. The Government can move away from the path of fiscal consolidation only in case of natural calamity, national security and other exceptional grounds which Central Government may specify.
The Finance Minister has to explain the reasons and suggest corrective actions to be taken, in case of breach.
The Act bans the purchase of primary issues of the Central Government securities by the RBI after 2006, preventing monetization of government deficit. The Act also requires the government to lay before the parliament three policy statements in each financial year namely
• Medium Term Fiscal Policy Statement
• Fiscal Policy Strategy Statement and
• Macroeconomic Framework Policy Statement.
To impart fiscal discipline at the state level, the Twelfth Finance Commission gave incentives to states through conditional debt restructuring and interest rate relief for introducing Fiscal Responsibility Legislations (FRLs). All the states have implemented their own FRLs.
The implementation of FRBM Act/FRLs improved the fiscal performance of both centre and states. The States have achieved the targets much ahead the prescribed timeline. Government of India was on the path of achieving this objective right in time.
However, due to the global financial crisis, this was suspended and the fiscal consolidation as mandated in the FRBM Act was put on hold in 2007-08.The crisis period called for increase in expenditure by the government to boost demand in the economy.
As a result of fiscal stimulus, the government has moved away from the path of fiscal consolidation. However, it should be noted that strict adherence to the path of fiscal consolidation during pre crisis period created enough fiscal space for pursuing counter cyclical fiscal policy.
Amendments to FRBM Act
Through Finance Act 2012, amendments were made to the Fiscal Responsibility and Budget Management Act, 2003 through which it was decided that in addition to the existing three documents, Central Government shall lay another document – the Medium Term Expenditure Framework Statement (MTEF) – before both Houses of Parliament in the Session immediately following the Session of Parliament in which MediumTerm Fiscal Policy Statement, Fiscal Policy Strategy Statement and Macroeconomic Framework Statement are laid.
Concept of “Effective Revenue Deficit” and “Medium Term Expenditure Framework” statement are the two important features of amendment to FRBM Act in the direction of expenditure reforms. Effective Revenue Deficit is the difference between revenue deficit and grants for creation of capital assets.
This will help in reducing consumptive component of revenue deficit and create space for increased capital spending. Effective revenue deficit has now become a new fiscal parameter. “Medium-term Expenditure Framework” statement will set forth a three-year rolling target for expenditure indicators.
As per the amendments in 2012, the Central Government has to take appropriate measures to reduce the fiscal deficit, revenue deficit and effective revenue deficit to eliminate the effective revenue deficit by the 31st March, 2015 and thereafter build up adequate effective revenue surplus and also to reach revenue deficit of not more than 2 % of Gross Domestic Product by the 31st March, 2015.
Vide the Finance Act 2015, the target dates for achieving the prescribed rates of effective deficit and fiscal deficit were further extended.
The effective revenue deficit which had to be eliminated by March 2015 will now need to be eliminated only after 3 years i.e., by March 2018. The 3% target of fiscal deficit to be achieved by 2016-17 has now been shifted by one more year to March 2018.
Committee to review the implementation of the FRBM Act
In the Union Budget 2016-17 it was proposed to constitute a Committee to review the implementation of the FRBM Act and give its recommendations on the way forward.
This was in view of the new 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.
A time has come to review the working of the FRBM Act, especially in the context of the uncertainty and volatility which have become the new norms of global economy.
The FRBM Review Committee has given its report recently. The Committee has done an elaborate exercise and has recommended that a sustainable debt path must be the principal macro-economic anchor of our fiscal policy.
The Committee has favoured Debt to GDP of 60% for the General Government by 2023, consisting of 40% for Central Government and 20% for State Governments. Within this framework, the Committee has derived and recommended 3% fiscal deficit for the next three years.
The Committee has also provided for ‘Escape Clauses’, for deviations upto 0.5% of GDP, from the stipulated fiscal deficit target. Among the triggers for taking recourse to these Escape Clauses, the Committee has included “far-reaching structural reforms in the economy with unanticipated fiscal implications” as one of the factors. Considering all these aspects, budget 2017-18 has pegged the fiscal deficit for 2017-18 at 3.2% of GDP and 3% in the following year.
1. Rule based fiscal policy is necessary to rationalize fiscal activism both during boom and downturn. Comment.
2. What are the merits of using fiscal policy during Crisis? What has been India’s experience in this regard?