Skip to main content

Fiscal Responsibility and Budget Management (FRBM) Act

The Government appointed a five-member Committee in May 2016, to review the Fiscal Responsibility and Budget Management (FRBM) Act and to examine a changed format including flexible FRBM targets. The Committee formation was announced during the 2016-17 budget by FM Arun Jaitely. The Panel was headed by the former MP and former Revenue and Expenditure Secretary NK Singh and included four other members, CEA Arvind Subramanian, former Finance Secretary Sumit Bose, the then Deputy Governor and present governor of the RBI Urjit Patel and Nathin Roy. There was a difference of opinion about the need for adopting a fixed FRBM target like fiscal deficit, and the divisive opinion lay precisely in not following through such a fixity in times when the government had to spend high to fight recession and support economic growth. The other side of the camp argued it being necessary to inculcate a feeling of fiscal discipline. During Budget speech in 2016, Mr Jaitley expressed this debate:
There is now a 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. There is also a suggestion that fiscal expansion or contraction should be aligned with credit contraction or expansion, respectively, in the economy.
The need for a flexible FRBM target that allowed higher fiscal deficit during difficult/recessionary years and low targets during comfortable years, gives the government a breathing space to borrow more during tight years. In it report submitted in late January this year, the committee did advocate for a range rather than a fixed fiscal deficit target. Especially, fiscal management becomes all the more important post-demonetisation and the resultant slump in consumption expenditure. The view is that the government could be tempted to increase public spending to boost consumption. but, here is the catch: while ratings agencies do look at the fiscal discipline of a country when considering them for a ratings upgrade, they also look at the context and the growth rate of the economy, so the decision will not be a myopic one based only on the fiscal and revenue deficits.
Fiscal responsibility is an economic concept that has various definitions, depending on the economic theory held by the person or organization offering the definition. Some say being fiscally responsible is just a matter of cutting debt, while others say it’s about completely eliminating debt. Still others might argue that it’s a matter of controlling the level of debt without completely reducing it. Perhaps the most basic definition of fiscal responsibility is the act of creating, optimizing and maintaining a balanced budget.
“Fiscal” refers to money and can include personal finances, though it most often is used in reference to public money or government spending. This can involve income from taxes, revenue, investments or treasuries. In a governmental context, a pledge of fiscal responsibility is a government’s assurance that it will judiciously spend, earn and generate funds without placing undue hardship on its citizens. Fiscal responsibility includes a moral contract to maintain a financially sound government for future generations, because a First World society is difficult to maintain without a financially secure government.
But, what exactly is fiscal responsibility, fiscal management and FRBM. So, here is an attempt to demystify these.
Fiscal responsibility often starts with a balanced budget, which is one with no deficits and no surpluses. The expectations of what might be spent and what is actually spent are equal. Many forms of government have different views and expectations for maintaining a balanced budget, with some preferring to have a budget deficit during certain economic times and a budget surplus during others. Other types of government view a budget deficit as being fiscally irresponsible at any time. Fiscal irresponsibility refers to a lack of effective financial planning by a person, business or government. This can include decreasing taxes in one crucial area while drastically increasing spending in another. This type of situation can cause a budget deficit in which the outgoing expenditures exceed the cash coming in. A government is a business in its own right, and no business — or private citizen — can thrive eternally while operating with a deficit.
When a government is fiscally irresponsible, its ability to function effectively is severely limited. Emergent situations arise unexpectedly, and a government needs to have quick access to reserve funds. A fiscally irresponsible government isn’t able to sustain programs designed to provide fast relief to its citizens.
A government, business or person can take steps to become more fiscally responsible. One useful method for government is to provide some financial transparency, which can reduce waste, expose fraud and highlight areas of financial inefficiency. Not all aspects of government budgets and spending can be brought into full public view because of various risks to security, but offering an inside look at government spending can offer a nation’s citizens a sense of well-being and keep leaders honest. Similarly, a private citizen who is honest with himself about where he is spending his money is better able to determine where he might be able to make cuts that would allow him to live within his means.
Fiscal Responsibility and Budget Management (FRBM) became an Act in 2003. The objective 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 with annual reduction target of 0.3% of GDP per year by the Central government. Similarly, revenue deficit has to be reduced by 0.5% of the GDP per year with complete elimination to be achieved by 2008-09. It is the responsibility of the government to adhere to these targets. The Finance Minister has to explain the reasons and suggest corrective actions to be taken, in case of breach.
FRBM Act provides a legal institutional framework for fiscal consolidation. It is now mandatory for the Central government to take measures to reduce fiscal deficit, to eliminate revenue deficit and to generate revenue surplus in the subsequent years. The Act binds not only the present government but also the future Government to adhere to the path of fiscal consolidation. 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.
Further, the Act prohibits borrowing by the government from the Reserve Bank of India, thereby, making monetary policy independent of fiscal policy. 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.
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.
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.the main provisions of the Act are:
  1. The government has to take appropriate measures to reduce the fiscal deficit and revenue deficit so as to eliminate revenue deficit by 2008-09 and thereafter, sizable revenue surplus has to be created.
  2. Setting annual targets for reduction of fiscal deficit and revenue deficit, contingent liabilities and total liabilities.
  3. The government shall end its borrowing from the RBI except for temporary advances.
  4. The RBI not to subscribe to the primary issues of the central government securities after 2006.
  5. The revenue deficit and fiscal deficit may exceed the targets specified in the rules only on grounds of national security, calamity etc.
Though the Act aims to achieve deficit reductions prima facie, an important objective is to achieve inter-generational equity in fiscal management. This is because when there are high borrowings today, it should be repaid by the future generation. But the benefit from high expenditure and debt today goes to the present generation. Achieving FRBM targets thus ensures inter-generation equity by reducing the debt burden of the future generation. Other objectives include: long run macroeconomic stability, better coordination between fiscal and monetary policy, and transparency in fiscal operation of the Government.
access to reserve funds. A fiscally irresponsible government isn’t able to sustain programs designed to provide fast relief to its citizens.

Originally posted here.

Comments

Popular posts from this blog

GST – Impact on Small Industry and the Informal Sector

The Goods and Services Tax (GST), that came into effect on 1st July, 2017, has been lauded as the most comprehensive contemporary reform of Indian indirect taxation. Aimed at creating a common, unified and integrated domestic market, allowing the free flow of goods and services across state lines, GST is supposed to deliver Indian industry and thereby the economy the competitive edge apparently lacking till now.
Reality is however a far cry from the picture painted by government. GST by creating platform a conducive to economies of scale and nullifying regional tariffs, is both conceptually and practically advantageous to big business and detrimental to the informal sector and small businesses.
These groupings, informal and small, though quite different have some degree of overlap. Informal business is overwhelmingly small but not all small businesses are informal. GST’s impact on these groups is quite different both with regard to extent of impact or in terms of results sought.
Small Bu…

Why Should Modinomics Be Bestowed With An Ignoble Prize In Economics? Demonetization’s Spectacular Failure.

This lesson from history is quite well known: Muhammad bin Tughlaq thought that may be if he could find an alternative currency, he could save some money. So he replaced the Gold and Silver coins with copper currency. Local goldsmiths started manufacturing these coins and which led to a loss of a huge sum of money to the court. He had to take his orders back and reissue Gold/Silver coins against those copper coins. This counter decision was far more devastating as people exchanged all their fake currency and emptied royal treasure. And nothing seems to have changed ideatically even after close to 800 years since, when another bold and bald move or rather a balderdash move by the Prime Minister of India Narendra Modi launched his version of the lunacy. Throw in Demonetization and flush out black money. Well, that was the reason promulgated along with a host of other nationalistic-sounding derivatives like curbing terror funding, expanding the tax net, open to embracing digital economy an…

Unfolding Crisis: The Case of Rising NPAs and Sinking Public Accountability

Public Finance Public Accountability Collective (PFPAC) released its first publication titled, "Unfolding Crisis: The Case of Rising NPAs and Sinking Public Accountability" on 14th  September, 2016 at Constitution Club, New Delhi. 




Download @ Unfolding Crisis: The Case of Rising NPAs and Sinking Public Accountability
For ordering hard copies of the report, please drop a mail to: Himanshu Damle