7 PM |The ugly truth about India’s adherence to the FRBM Act|31st January 2020

Context:FRBM Act.

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• Fiscal deficit has become a key factor to watch out for in every Budget presentation. It is considered the most important marker of a government’s financial health.

Budget:

• The word ‘budget’ has not been used in the Constitution of India. Rather Article 112 of the Constitution of India mentions the term “Annual Financial statement”.
• The budget is a statement of the estimated receipts and expenditure of the Government of India among other things. Overall the budget contains the following:
• Estimates of revenue and capital receipts;
• Ways and means to raise revenue
• Estimates of Expenditure
• Details of the actual receipts and expenditure of the closing financial year and the reasons for any deficit or surplus in that year 
• Economic and financial policy of the coming year, that is, taxation proposals, prospects of revenue, spending programme and introduction of new schemes

Different Types of Budget Deficits:

There can be different types of the deficit in a budget depending upon the types of receipts and expenditure we take into consideration. Accordingly, there are three concepts of the deficit:

• Revenue deficit
• Fiscal deficit and
• Primary deficit.

Revenue Deficit:

• Revenue deficit is excess of total revenue expenditure of the government over its total revenue receipts.
• It is related to only revenue expenditure and revenue receipts of the government.
• Alternatively, the shortfall of total revenue receipts compared to total revenue expenditure is defined as revenue deficit.
• Revenue deficit results in borrowing. Simply put, when government spends more than what it collects by way of revenue, it incurs revenue deficit.
• Revenue deficit includes only such transactions which affect current income and expenditure of the government. 

Fiscal Deficit:

• The difference between total revenue and total expenditure of the government is termed as fiscal deficit. It is an indication of the total borrowings needed by the government. 
• Generally fiscal deficit takes place either due to revenue deficit or a major hike in capital expenditure. Capital expenditure is incurred to create long-term assets such as factories, buildings and other development.
• A deficit is usually financed through borrowing from either the central bank of the country or raising money from capital markets by issuing different instruments like treasury bills and bonds.

• Importance of fiscal deficit: Fiscal deficit indicates the borrowing requirements of the government during the budget year. By implication, greater fiscal deficit signifies greater borrowing by the government. The extent of fiscal deficit is an indicator of the amount of expenditure for which the government has to borrow money.
• Some economists like J.M. Keynes say that a fiscal deficit situation is beneficial as it assists countries in coming out of recession. However, other experts opine that governments should avoid deficits in favour of balanced budget policy.

Primary Deficit:

• Primary deficit is defined as fiscal deficit of current year minus interest payments on previous borrowings.
• In other words whereas fiscal deficit indicates borrowing requirement inclusive of interest payment, primary deficit indicates borrowing requirement exclusive of interest payment.

Fiscal Responsibility and Budget Management (FRBM) Act 2003:

• The Fiscal Responsibility and Budget Management (FRBM) Act was enacted in 2003 which set targets for the government to reduce fiscal deficits.
• The primary objective was the elimination of revenue deficit and bringing down the fiscal deficit.
• The other objectives included:
• To ensure that the government did not borrow beyond rational limits.
• Borowing for consumption has to be brought to zero over a period.
• Only borrowing for asset creation was to be allowed.
• Total internal debt of the government of India should be limited.
• RBI should not be the primary lender.
• Features of the FRBM Act:
• It was mandated by the act that the following must be placed along with the Budget documents annually in the Parliament:
• Macroeconomic Framework Statement
• Medium Term Fiscal Policy Statement and
• Fiscal Policy Strategy Statement
• It was proposed that the four fiscal indicators i.e, revenue deficit as a percentage of GDP, fiscal deficit as a percentage of GDP, tax revenue as a percentage of GDP and total outstanding liabilities as a percentage of GDP be projected in the medium-term fiscal policy statement.
• Targets and fiscal indicators as per the FRBM Act: The central government agreed to the following fiscal indicators and targets, subsequent to the enactment of the FRBMA
• Revenue deficit to be eliminated by the 31st of March 2009. A minimum annual reduction of 0.5% of GDP.
• Fiscal Deficit to be brought down to at least 3% of GDP by 31st of March 2008. A minimum annual reduction – 0.3% of GDP.
• Total Debt to be reduced to 9% of the GDP (a target increased from the original 6% requirement in 2004–05). An annual reduction of – 1% of GDP.
• The purchase of government bonds by RBI must cease from 1 April 2006.

Adherence to FRBM Act:

• Between 2004 and 2008, the Indian government had made giant strides on reducing both revenue deficit and fiscal deficit. But this process was reversed thereafter thanks largely to the Global Financial Crisis and a domestic slowdown. Since then, there have been several amendments to the Act essentially postponing the targets.
• In Budget 2016-17, a panel under the chairmanship of N.K Singh was constituted to review the Fiscal Responsibility and Budget Management Act. The main recommendations of NK Singh committee:
• Committee recommended that the combined debt-to-GDP ratio of Centre and States should be brought down to 60% by 2023(40% Centre and 20 % States) as against existing 49.4% of centre and 21% of states.
• For fiscal consolidation, the centre should reduce its fiscal deficit from the current 3.5% (2017) to 2.5% by 2023.
• The central government should reduce its revenue deficit steadily by 0.25 percentage (of GDP) points each year, to reach 0.8% by 2023.
• The committee has recommended an Escape Clause to accommodate counter cyclical fluctuations such as Boom or Recession or in case of any natural calamities.
• The Committee proposed to create an autonomous Fiscal Council with a role of preparing multi-year fiscal forecasts, recommending changes to the fiscal strategy, improving quality of fiscal data, advising the government if conditions exist to deviate from the fiscal target, and advising the government to take corrective action for non-compliance with the Bill
• Changes made in 2018 amendment:
• The central government shall reduce the fiscal deficit by an amount equivalent to 0.1 percent or more of the gross domestic product at the end of each financial year beginning with the financial year 2018-19, so that fiscal deficit is brought down to not more than 3 percent of the GDP by 2020-2021.
• Union government stopped targeting revenue deficit and instead focussed only on fiscal deficit.

Significance of Revenue deficit:

• Revenue Deficit is shown as a reference indicator in the Medium-term Fiscal Policy Statement (MTFP). The Revenue Deficit of the government has several implications, such as, it has to be met from the capital receipts, because of which a government either borrows or sells its existing assets. This brings in a reduction in assets.
• Also, to meet its consumption expenditure, since the government uses capital receipts, it leads to an inflationary situation in the economy.
• With more and more such borrowings, along with interest, the burden to repay the liability also increases which, in the future, results in huge revenue deficits.

Conclusion:

Since there is no compulsion to reduce revenue deficit, the government has, over the past couple of years, been containing the fiscal deficit by reducing its capital expenditure. As a result, India has now reached a point where adhering to the FRBM Act is actually sending a contractionary pulse. In other words, adherence to FRBM Act is achieving the exact opposite of what it was supposed to do.

There is a need to revert back to the original FRBM Act if 2003 by recognising and prioritising the reduction in revenue deficit. Doing this will help the government boost the kind of expenditure that actually increases the GDP.

Source: https://indianexpress.com/article/explained/explained-union-budget-2020-the-ugly-truth-about-indias-adherence-to-the-frbm-act-6243108/